What is the function of the lender of last resort?

• A. Provide liquidity to banks facing short-term funding problems
• B. Set fiscal policy
• C. Determine unemployment rate
• D. Regulate stock prices

Answer: (A)

Lending emergency liquidity to banks facing short-term funding problems is what the lender of last resort does. In a crisis, banks may struggle to obtain funds from usual markets and fear a run on deposits. The central bank steps in to provide temporary funds, often against collateral, so banks can meet withdrawal demands and keep payment systems operating. This stabilizes the financial system and helps maintain confidence, preventing a broader credit squeeze.

This isn’t about setting government spending or taxation, which is fiscal policy; it isn’t about measuring or determining unemployment, which is a labor market statistic; and it isn’t about regulating stock prices, which is not the central bank’s primary function. The focus here is on supplying liquidity to solvent banks during short-term funding stress to preserve financial stability.