So far, throughout this primer, I’ve claimed that central banks have one overarching task to perform: their job, I said, is to “regulate the overall availability of liquid assets, and through it the general course of spending, prices, and employment, in the economies they oversee.” I’ve also shown how, prior to the recent crisis, the Fed pursued this task, sometimes competently, and sometimes ineptly, by means of “open-market operations,” meaning routine purchases (and occasional sales) of short-term Treasury securities.
But this picture isn’t complete, because it says nothing about central banks’ role as “lenders of last resort.” It overlooks, in other words, the part they play as institutions to which particular private-market firms, and banks especially, can turn for support when they find themselves short of cash, and can’t borrow it from private sources.
For many, the “lender of last resort” role of central banks is an indispensable complement to their task of regulating the overall course of spending. Unless central banks play that distinct role, it is said, financial panics will occasionally play havoc with nations’ monetary systems.
Eventually I plan to challenge this way of thinking. But first we must consider the reasoning behind it.