Discount Window Stigma: An Experimental Investigation

Abstract:
A core function of central banks is to act as a “lender of last resort” to the banking system. In the U.S., the Federal Reserve uses the Discount Window (DW) to fulfill this task. Historically, however, the DW has been little used, even when banks faced acute liquidity shortages. This lack of DW borrowing is commonly attributed to stigma, as illustrated by Chairman Bernanke’s quote above. The economic consequences of DW stigma may be severe for the financial system (e.g. fire-sales, excessive self-insurance, failures). Further, DW stigma may prevent central banks from effectively providing emergency liquidity and implementing monetary policy. Despite its relevance, DW stigma is not a well-understood phenomenon, in large part because of the lack of data. In this paper, we use lab experiments to generate data in order to better understand DW stigma and how to eliminate it. To the best of our knowledge, this is the first paper that relies on experimental methods to address DW stigma and more generally the provision of emergency liquidity by central banks.