Matthieu Chavaz, David Elliott and Win Monroe
Large-scale provision of long-term funding to banks has become a central bank tool to support credit supply during downturns. However, scholars have worried that allowing banks to rely on public funding could create moral hazard and crowd out private funding. In a recent paper, we address these concerns by showing that central bank and private funding can be complements rather than substitutes. The mere availability of central bank funding improves private wholesale funding conditions, thus supporting lending without central bank funding being used. This ‘equilibrium’ effect makes central bank funding more powerful than previously thought. Finally, the fact that central bank funding comes with strings attached can help to explain why it is an imperfect substitute for private funding.
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