Liquidity Crises and the Market-Maker of Last Resort

Charles Kahn, David Marshall, Robert L. McDonald

We study market illiquidity in an economy subject to non-fundamental shocks. Asset trading occurs via decentralized one-on-one bargaining. The model has multiple rational expectations equilibria; we associate certain Pareto inferior equilibria with liquidity crises. The government can improve welfare by acting as a "market-maker of last resort" (MMLR), purchasing assets at above-market prices. Several policies employed by the US during the financial crisis are examples of MMLR. We consider "aggressive" and "conservative" MMLR policies. The aggressive policy supports the unique pareto optimal equilibrium. The conservative policy, which embeds a "no-bailout constraint," only supports an inefficient equilibrium

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Year of publication:	March 2025
Authors:	Kahn, Charles M. ; Marshall, David Aaron ; McDonald, Robert L.
Institutions:	National Bureau of Economic Research (issuing body)
Publisher:	Cambridge, Mass : National Bureau of Economic Research
Subject:	Liquidität \| Liquidity \| Finanzkrise \| Financial crisis \| Lender of Last Resort \| Lender of last resort \| Pareto-Optimum \| Pareto efficiency \| Geldpolitik \| Monetary policy \| Schuldenübernahme \| Bailout \| USA \| United States