[Current Affairs Terms]Bagehot's Dictum

Bagehot's Dictum: Central Bank's Crisis Response Principle

Bagehot's dictum refers to the principle that central banks should proactively prevent financial market collapses by supplying ample liquidity to financial institutions during crises, but must impose penalties such as higher-than-market interest rates to avoid moral hazard.

This concept, advocated by British economist and journalist Walter Bagehot, has become the standard for defining the central bank's role as the lender of last resort.

Paul Tucker, former Deputy Governor for Financial Stability at the Bank of England (BOE), summarized Bagehot's dictum as follows: "To avoid panic, the central bank should lend early and freely, to solvent firms, against good collateral, and at a high rate."

This is a norm also observed by the Bank of Korea, South Korea's central bank.

In response to financial market strains following interest rate hikes in the second half of 2022, the Bank of Korea implemented temporary liquidity supply measures such as repurchase agreement (RP) purchases.

Bank of Korea Governor Rhee Chang-yong explained, "At the time, the Bank's liquidity provision was a temporary and partial measure that did not undermine the overall monetary tightening stance, and by applying interest rates higher than market rates, it was consistent with Bagehot's dictum."

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