Domestic Lender When and How Much? There

Domestic lender when and how much? There are several measures that banks have taken over the years to ensure they do not run the risk of overtrading; bank of England in 1772 used the selective limitation of discounts which was heavily criticized, the same bank used prorate discounts in 1797, tighten up on eligibility requirements for collateral is yet another measure and shortening the duration maturity of eligible bills.

The concern on over trading by banks has led banks to behave like private institutions worried about their own safety rather than the stability of the system.

This then raises the question, how much should the central bank expand the money supply? A case in hand is the New York Fed that was operating under a directive from the Board of Governors in Washington that permitted it to buy $25 million of government bonds a week, though in 1929 the Fed defied this and bought more that the allowed limit and went further to advice the board to lift the limitation of $25 million per week.

This was informed by the hard financial times that the country was undergoing prompting the general situations of discounts running off rapidly, interest rates falling sharply, and hence the need for a lender of last resort. The board reluctantly lifted that limitation taking into account these prevailing conditions. When there is panic and the stock market is threatened with a crash then the amount is not the ultimate consideration here but more significantly the timing of the introduction or use of the lender of last resort.

Most monetarists maintain that as long as money supply keeps increasing at a constant rate, then there is no need for the lender of last resort. This was backed by the observed inadequacy of open market operations weeks before the panic in 1929, a fact that enabled the New York banking system to take over the call loans of most of out-of-town banks, a fact that led to decline in prices of attached property and stocks hence leading to the depression.

This shows the introduction of the bank of last resort was not timely but rather too early with catastrophic effect on value of property. Timing hence comes in as the most important aspect in a crash situation since even if excess amount is poured out in the market, there are other techniques that can be employed to mop it.