In so doing, asset prices will be pushed on a downward spiral, which exacerbates banks’ distress and leads to further credit and asset price losses and a further deepening of the confidence crisis. The general scarcity of credit, in turn, leads to a substantial worsening of the macroeconomic outlook.
The potential negative aggregate effects of such systemic liquidity crises can jeopardise price stability over the medium term. The lender-of-last-resort function of central banks is the classic solution to the run problem for individual banks. The central bank stands ready to provide liquidity to the distressed bank at a penalty rate against adequate collateral.