Rethinking the lender of last resort

According to John Maynard Keynes, money, as the institution that founds the exchange system, is a link between the present and the future. The existence of a monetary economy of production is founded on credit relations, organized markets of financial assets, speculation and uncertainty. In a monetary economy, there is a set of interrelated balance sheets and cash flows among income-producing companies, households and banks. As Keynes highlighted, the tensions between money as a public good, issued by central banks, and money as a private good, created by banks, is inherent to the capitalist institutional set up.  On behalf of these tensions, trust is decisive to support financial stability.

Looking back, Walter Bagehot warned that trust influences the dynamics of finance. In his seminal 1873 book, Lombard Street, he says:

The peculiar essence of our banking system is an unprecedented trust between man and man: and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it.

One of Bagehot’s main concern was about the central banks’ most feasible instrument to defeat panics in the banking sector. In his view, the main function of the lender of last resort involves the quick provision of liquidity to banks in order to accommodate sudden and sharp increases in the demand for liquidity. Thus, central banks may influence the evolution of the credit markets by changing the availability and cost of the banks’ demand for liquidity (reserves). More generally, the lender of last resort would not prevent financial shocks, but minimize their impacts on the economy and society.  Its aim would not be the prevention of bank failures at all costs, but rather the prevention of the spread of liquidity risk to sound institutions

More recently, the 2008 global financial crisis and the unprecedented actions of the Federal Reserve, European Central Bank and the Bank of England, for example, suggest the need to rethink the role of the lender of last resort. The scope of the recent central banks’ interventions has been expanded in order to include not only the provision of liquidity as lender of last resort, but also to include the expansion of repurchase agreements as buyer of last resort and the supply of liquidity to specific markets  as market maker of last resort.

Considering the historical financial changes and the relevance of financial issues to the economics curriculum, some interesting questions arise: Is the lender of last resort theory proposed by Bagehot old fashioned? Or Can we include the actions of the central bank as market maker of last resort and buyer of last resort within the scope of the lender of last resort interventions aimed to stabilize the financial markets?


  1. Central banks, such as our Federal Reserve, are tasked to maintain the value of money/price stability/inflation and maintain an acceptable employment rate in the economy. In this era of fast communications and ubiquitous computing power, it is time to replace central banks with centralbank.exe just as vehicle operators will be replaced by cardriver.exe.

  2. Maria Alejandra Madi said:

    Thanks for your comment. Could you expand the meaning of the idea of centralbank.exe?


    • CentralBank.exe is short hand for a computer program which could make the decisions nominally done by the FOMC but doing a much better job. It could analyze more data, make faster decisions and, hopefully, using correct negative feedback, create a truly stable economy. I believe it is doable with existing technology and infrastructure.

      • Technology can’t solve the problem. And neither can central banks. When the powerful siphon off the major portion of the money supply and turn it into multiple principal debts of the same money, borrowers will lose their collateral in default whenever the growth of debt to banks slows down for ANY REASON.

        THERE IS NO ESCAPE from within this limited concept of money.

      • I agree with much of what you say but there is “free” money in the economy, money that does not have to be repaid to banks and was not created by banks. I mentioned three examples above, coins, US Notes and silver certificates. Technology with control principals using negative feedback could produce a stable economy but the congress would have to take on the chore of managing the money supply and not the FOMC. That would eliminate most of the CB’s powers, restoring that power to congress where it belongs. A guaranteed income for all could be a very effective tool for control of the money supply and establishing economic stability by increasing the stipend in slow times and reducing it in hot times. The beauty of doing it via computers is that it could react fast and only small changes would be needed to “stay the course.” Taxes would be another strong tool making small adjustments in taxes on a weekly or even daily bases. It is doable and it could not have been done in 1913 when the system we have now was born.

      • “there is “free” money in the economy, money that does not have to be repaid to banks and was not created by banks”.

        Once a gold coin, US note, silver certificate, Bitcoin or whatever has been LENT into the economy by those with excess, it is “money as debt” just as surely as bank credit is. When it is subsequently acquired and re-lent by those with excess it creates 2 or more principal debts of the same money. Now you have Perpetual Debt and the grow-or-collapse imperative.

        The same would happen if money were a limited supply of cowrie shells. As I said before there is no escape from within this concept of money as a monopolistic quantity of ANYTHING.

      • Yes, if LENT but when SPENT by the government into the economy then it stays unless removed by taxes. US notes with the red serial numbers are still circulating in the economy although none have been spent into the economy since 1971. Joe Firestone’s proposal to mint HSC such as a 10T$ coin illustrates this fact also. Coins are/can be spent at face value into the economy with the government taking the full seigniorage.. Fed Reserve notes, on the other hand, are free to the Fed but printed by the BEP. The seigniorage disappears in the labyrinth of the CB and it’s covey of commercial banks.

      • ” if LENT but when SPENT by the government into the economy then it stays unless removed by taxes. ”

        If the goal is freedom from the growth imperative that is driving us to planetary ecocide, then it makes zero difference that the initial money creation debt is government spending, not private debt.

        In a stable situation, every dollar spent must be removed by taxes to prevent devaluation, so it is just taxes spent in advance, another form of “money as a debt-of-itself on a schedule” just like bank credit.

        What happens in between issuance and redemption for taxes? After it is spent by the government into circulation it is earned and spent or earned and lent or earned and saved in a bank (sequestered and replaced with new M1 credit = re-lent).

        earned and spent… earned and privately re-lent …spent earned saved in a bank and re-lent… spent earned saved in a bank and re-lent… spent earned saved in a bank and re-lent. Total money = ONE dollar, Total principal debt of that dollar = 4 dollars.

        PLUS it is owed to the government for taxes.

        You’re a retired engineer. This is pretty simple mathematical logic. Prove me wrong with math and logic.

      • Let’s start at square one. The government spends money into the economy. It cannot tax before it spends. That is simple logic. Next it takes out some of the money and spends more. What is left in the economy is called the national debt. Simple. All of the money spent by the government cannot be taken out. That would leave none for the economy. Taxes are an act of money destruction, not revenue production as bookkeepers would like you to believe. A classic description of issuance of money and taxing is described in The Colony of Virginia’s Money Act, March 1760. It is a very interesting read.Google will find a copy for you very quickly.

      • Like the economists and sovereign money reformers who could not refute my my documented facts, simple logic and irrefutable grade school arithmetic, you start at square one and skip to the last square, completely ignoring what happens to money in the interval. I call that very fuzzy thinking.

        In the real world, between its creation and repayment/destruction either as government spent fiat or bank credit, money gets re-lent several times over creating far more principal debt than there is money to pay it. How can you just ignore this?

        Limiting money to that spent into circulation by government will only make things worse. Wrong analysis, wrong solution.

        Steve Keen, the AMI and Positive Money all failed to refute my simple argument. Read about the debate here:

      • I suspect you have read/reviewed the material in Assuming you have, do you agree with their position that making commercial banks trust institutions instead of money-creation-by-loan institutions would cause the national debt to be paid down to zero with excessive left over?

    • Government should be able to spend money redeemable for taxes and never be in debt to banks or anyone else except to provide Government services. My objection is that the proposed seignorage plan is not designed as a full circle.

      As for the proposal at, I debated this issue with one of the authors Uli Kortsch, Global Partners Investments who made no attempt to refute my argument. He just dismissed it. I tried to debate it with another author, Michael Kumhof, International Monetary Fund by critiquing one of his articles. Kumfoff promptly quit the discussion group. I challenge the very basis of their understanding and they don’t want to hear it.

      From their website:
      “Under our current fractional reserve banking system a deposit made at a bank constitutes a liability to the bank, as the bank now has the obligation to repay that deposit to the depositor when demanded (called a “demand deposit”). However, until demanded back, the bank has a largely free hand as to how to use that deposit in order to make a profit from it.
      The bank therefore converts the short-term deposit into a long-term asset, usually by issuing a loan to a borrower or buying Treasuries with it. ”

      This is self-contradictory nonsense from some of the worlds’ supposed experts.

      The bank does NOT invest someone’s savings deposit. Nor does it need to.

      1. A Treasury purchase or a new signed loan agreement (+ collateral) is the asset that creates new bank credit.
      2. Borrower’s liability = Bank’s liability = bank credit money
      3. A savings deposit, if it is an incoming liability of another bank, cancels out an outgoing liability to another bank.
      4. The savings deposit is now a DEFERRED liability.
      5. The bank may now legally REPLACE it with a new loan from the same reserve base.
      6. Once replaced, there are now 2 principal debts of the same bank credit.
      7. The new loan is also deposited as savings and replaced. There are now 3 principal debts of the same bank credit.
      8. The new loan is also deposited as savings and replaced. There are now 4 principal debts of the same bank credit.

      Do their proposed reforms solve the problem? NO.

      Puzzle 1 Current System
      ALL Money is created as M1 DEBT to a BANK
      M2 = SAVINGS plus M1
      SAVINGS can be replaced with new M1
      M2 = 4 M1 according to Fed statistics.
      Therefore, for every dollar even possibly available to be earned (M1), there is a minimum of $4 in principal debt (M2).

      Puzzle 2 Their Proposed System
      ALL Money is created as fiat cash and lent out as credit for cash by banks
      M1 = credit for cash
      M2 = SAVINGS plus M1
      SAVINGS are actually lent out
      M2 = 4 M1 according to Fed statistics.
      Therefore, for every dollar even possibly available to be earned (M1), there is a minimum of $4 in principal debt (M2).

      Just TRY refuting the argument Charles. Just TRY.

      • Are you including in your analysis the fact that when a loan to a bank is repaid the principal of the loan disappears from the economy? That fact is easily proved but not obvious to everyone. The bank, of course, keeps the interest and that comes from the economy too.

      • Of course I know that the principal is extinguished. Try extinguishing a total principal debt of $12 trillion when the only money available is $3 trillion.

        This is what you are all ignoring. In the USA, where reserves are only required for checking balances, Fed statistics themselves show that:

        M2 = TOTAL PRINCIPAL DEBT to BANKS on which interest and principal payments must be made on time = $12 Trillion

        M1 = TOTAL available bank credit POSSIBLY available to be earned to make those interest and principal payments = $3 Trillion

        The only way you can fail to see this is to ignore the true nature of money which is precisely what the defender of the current system do. This includes all the brainwashed economists

        Economists and a Pile of Nuts 2:17

        Here’s is my proposed solution, much less disruptive as well.

        How to Turn 9 Trillion Dollars of Impossible Debt into 9 Trillion Dollars of New Funding.

      • Extinguishing a 16T$ debt held by an issuer of the same money such as the USA is zero problem. A user of the money, if they held such a debt, would have a problem but not the issuer.

      • You still haven’t addressed my simple mathematical proof.

      • I do not understand your statement the “…seigniorage plan is not designed as a full circle.” I agree with the first part of your statement, “Government should be able to spend money redeemable for taxes and never be in debt to banks or anyone else except to provide Government services.”, except I would replace “should” with can.” It has happened many times in our history and still does with coins.

      • Taxes cannot be redeemed until spending has occurred. The cycle is Spend>Tax, not Tax>Spend. The amount of money not removed by taxes is called by two names, One is “national debt” and the other is “money in the economy.” That is the simplest form of sovereign government issuance by spending of money. That cycle, in and of itself, can lead to a stable economy IF taxes are viewed and used to maintain price stability and the false narrative that taxes are needed for government spending is rejected as it should be. The question of the banks creating credit to enable an endogenous credit or money supply is a totally different issue. .

      • “That is the simplest form of sovereign government issuance by spending of money. That cycle, in and of itself, can lead to a stable economy IF taxes are viewed and used to maintain price stability”.

        I have repeatedly presented you with a simple mathematical proof that the commonly believed statement above is entirely wrong because the analysis of the problem is entirely wrong. The sovereign money monopoly will only make things worse.

        Like every economist I have challenged all you can do is ignore that 1+1+1+1 = 4 and repeat your ideological beliefs. That puts you in the same category as any other fundamentalist BELIEVER. That you have lots of company doesn’t mean you are correct.

      • There are many examples in history of that being done so we have data, not just speculation. The examples extend from colonial times to the present.

      • What is different now is that we are actually facing ecological limits to growth and cannot any longer use a money system that is dependent on perpetual growth of the money supply to avoid mathematically-caused defaults which are an inevitable consequence of borrowed money (in ANY form) being recursively relent 1, 2, 3 and more times, rather than being available to be earned debt-free by the borrowers.

        One does not even need fiat money or banks to make this happen. All you need is money that is a limited supply of anything and economically powerful rich people. See page 3.

  3. Ernesto Vaihinger said:

    ¿Existe algo distinto a lo que en general se identifican como operaciones de mercado abierto?

    • Maria Alejandra Madi said:

      Hi Ernesto,

      Thanks for your comment. The main target of open market operations as an instrument of monetary policy is to manage the nominal interest rate. Central Banks’ liquidity management is a correlated issue – on behalf of the cost of reserves and the expected returns of banks’ assets).

      When considering the Central Bank as the buyer of last resort, we can highlight, for instance, the ECB’s interventions as the buyer of last resort via the Outright Monetary Transaction program (OMT). The OMT significantly increased the market prices of sovereign bonds, leading to a permanent reversal of private funding flows to Eurozone banks holding these bonds.

      In this case, the main target of the Central Bank’s interventions is to affect the risk and return of banks’ assets. Thus, the Central Bank stimulates the increase of new sources of liquidity for financial institutions.

      We need to re-start talking about the conference!


  4. “money, as the institution that founds the exchange system, is a link between the present and the future.”

    This bland and shallow statement obscures the reality. You are welcome to publish my description of money below. My 2006 movie, Money as Debt, viewed by many millions worldwide in 24 languages, predicted the Crash.

    Money is created as a principal debt of itself and is then re-lent several times via the banking system and independent of it, creating Perpetual Debt and the grow-or-collapse imperative. Money on the macro scale is not an asset nor is it a “link”.
    It is a black hole of impossible principal debt and only continuous growth of principal debt to banks (retail or central) can keep us from falling into the ever expanding hole.

    Only mass default can clear the excess principal debt and shrink the hole.

    My definition explains what happened and will happen again… and again.

    Peer-reviewed paper published by the World Economics Association:
    Proposed new metric: the Perpetual Debt Level

    I also offer a way out.

    How to Turn 9 Trillion Dollars of Unpayable Principal Debt into 9 Trillion Dollars of New Funding (PDF)

  5. Maria Alejandra Madi said:

    Thanks for your comment. I have accessed your links and appreciated your developements on money and debt.

    In my post, the idea of money as a “link” between the present and the future is related to the role of money as a store of value. In the Keynesian approach, this role is the foundation of the main critique oriented to the neoclassical paradigm where money is only means of payment.

    When considering money as a store of value, Keynes introduced uncertainty and the lack of effective demand problem. Taking into account this backgorund, Minsky developed the theory of financial fragility where money creation (debt) and speculation are both sides of banking activities.


  6. I can say from 10 years experience that economists fail (actually REFUSE) to fully understand what “money as a debt of itself on a schedule” really means.

    Money is a store of someone else’s debt to paid back on a DEFINITE SCHEDULE. Therefore, savings are the INDEFINITE INTERRUPTION of this scheduled debt repayment. Thus the system is designed to cause default in the absence of perpetual growth of debt to banks. Until economists stop thinking that money is a neutral “means of payment ” and a “store of value”, there is no possibility of escape.

    Witness the debate I had with the leading lights of sovereign money reform and well-known economist Steve Keen. Keen et al failed to refute any of my facts logic or arithmetic. Instead Keen just chose to call me names and dismiss me as a “crank”.

    Sovereign Money Critique

  7. Maria Alejandra Madi said:

    In the discussion, we need to consider that there are two different levels of analysis. One is related to money and the foundations of the exchange system. The other is related to money in the context of the historical evolution of the capitalist institutional set-up. See for example the Marxian two levels of analysis analysis of money in Capital’s Book I and Book III. Also in the General Theory, Keynes distinguishes the two levels, see Chapter 12 and 17.


  8. My analysis presented in under 3 minutes in a cartoon (link below), is derived from the actual rules and practice of banking as described in the publications of the Bank of England, the Federal Reserve, the Bank of Canada and the ECB., I challenge you to stop changing the subject and FACE THE FACTS. The argument is so simple. If you can’t refute my facts, logic or arithmetic then I am correct and I don’t give a fig what Marx or Keynes were on about. Marx predated the current system and Keynes was an accomplice in setting it up.

    Economists and A Pile of Nuts 2:17

    • I believe most folks understand and believe what you say. The true error, in my view, is calling the bottom of that nut pile “money” when banks actually call it what it is, “credit” which I describe as a hole waiting for money to fill it. One needs to consider also, how the top of that nut pile got there. Government spending is constrained from adding to or subtracting from the money supply by the bookkeeping rule that spending is equal to taxes plus borrowed/treasuries sold. The only way the top of the nut pile got there is from US Notes spent until 1971, silver certificates spen under JFK and coins. We do have two very different monetary systems at work, coins and paper currency issued via the CB. In 1913 they did not have a better idea of how to control the money supply so they went with an endogenous system which we still have today. That is what you are really talking about and you are correct to talk about it. Our present technologies and infrastructure offer much better ways to manage the money supply than the endogenous method installed over a century ago.

      • I must correct my previous reply. The smaller portion is M1 which is checking (bank credit – major portion) plus cash small portion).

  9. Sorry, Charles, you misunderstand the illustration so I don’t think most people understand or agree.

    This is NOT about the ratio of any variety of notes or fiat money to bank credit as you have misinterpreted it. None of the nut pile in the cartoon is “money” as in cash & coins. All of it is COMMERCIAL BANK CREDIT created as a promise to pay it back to a RETAIL BANK, almost all of it on a schedule. The smaller portion is checking accounts, that part which constitutes the CURRENT LIABILITIES OF BANKS, the only part of endogenous money that borrowers can earn to make payment. The larger part is savings, endogenous money created as debt on a schedule that is INDEFINITELY UNAVAILABLE to the borrowers that created it.

    Credit is not a hole waiting for money to fill it. Credit is a hole waiting to be refilled with the same credit, except that the credit created has been effectively re-lent several times within the banking system and outside of it, creating in the USA, a minimum of 4 ONE DOLLAR HOLES FOR EVERY DOLLAR AVAILABLE TO FILL THEM. At the Crash of 2008, there was an unprecedented 5.26 one dollar holes for every dollar.

    Economists are as utterly blind to this as the general public.

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