Lombard Street revisited? Bagehot’s rules and Bernanke’s interpretation

Ben Bernanke first referred to Walter Bagehot's Lombard Street when he was in the chair of the Board of Governors, and when the Federal Reserve responded to the global financial crisis that began in August 2007. While the literature has dealt with the practice of the Federal Reserve and its compliance or otherwise with Bagehot's rules, it has not detailed Bernanke's theory of lending in last resort and the underlying interpretation of Bagehot's rules. Thus, our approach is not empirical but theoretical. We first recall Bagehot's arguments especially regarding the respective levels of interest rates. Then we show how Bernanke met Bagehot and how he revisited Bagehot's rules. We find that Bernanke's approach can be sustained under theoretical conditions—notably working on the assumption that the fundamental value of financial assets can be identified. We conclude by emphasising that the debate can be either restricted to the question of moral hazard, or broadened to the question of the financial cycle.