The Separation Principle

Central banks play a role in ensuring the stability of the economy. Two of their primary functions are as the lender of last resort and the management of monetary policy. While both are related to the overall stability of the economy, they address different aspects of it.

The lender of last resort function is responsible for addressing financial stability concerns, such as bank runs or liquidity issues during times of crisis. On the other hand, monetary policy is responsible for addressing price stability and full employment. In general, the lender of last resort function is reactive, while monetary policy is proactive.

The separation principle is the idea that a central bank should, in practice, separate its lender-of-last-resort function from its monetary policy function. The principle is intended to prevent conflicts of interest and ensure that the two functions are carried out appropriately and independently.

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