Trade Liberalization and the Lender of Last Resort

Trade liberalizations create conditions conducive to a financial crisis. Previous work has emphasized the role of moral hazard when a central bank guarantees financial system liabilities following a liberalization. This paper emphasizes the importance of “time-to-build” considerations that create financial fragility following a trade liberalization. Financing constraints during the adjustment period create a need for liquidity provision by central banks that is conceptually distinct from a blanket guarantee on bank liabilities. The control of bank moral hazard becomes politically difficult as traditional instruments, which rely on constraining the growth of banks, come into conflict with the increased credit demands of the liberalized economy.