ABSTRACT
I perhaps owe my readers an apology for referring once again to the doctrine of lender of last resort. The late Fred Hirsch brought the subject to the forefront of discussion with a brilliant paper half a generation ago (Hirsch, 1977). Hugh Rockoff discussed it earlier in this series honouring Henry Thornton (1986). Governor Carlo Ciampi of the Bank of Italy lectured on the subject in his own country in February of this year (Ciampi, 1992). The issue has been pursued in at least two of my books (1973 [1986], Chs. ix, x; 1984 [1993], passim, but especially pp. 277-83 of the 1984 edition). On this occasion, however, my purpose is not to defend the doctrine in the face of monetarists who believe that the money supply should be fixed, or grow at a fixed rate, rather than be allowed to expand in periods of widespread illiquidity and distress. That issue, to my mind, has been settled in favour of a lender of last resort in financial crisis. Rather, I suggest that the world may have pushed the doctrine too far with deposit insurance for commercial banks and thrifts, the rescue from bankruptcy of such bodies as New York City, some corporations such as Penn Central, Lockheed and Chrysler Corporation, banks ‘too big to fail’ even though their deposits exceed insured limits by wide margins, brokerage houses that loaned to such a commodity speculator as Bunker Hunt, who tried to corner the world silver market in the early 1980s. Even now in Japan, government money is called upon to make whole an institution owned by a rich bank, the troubles of which were caused by fraud rather than mistakes (The Economist, 1992, p. 105). Many high-minded principles suffer from entropy or decay over time, and the lender of last resort may be one of them.
