Does the ECB act as a lender of last resort during the subprime lending crisis?: Evidence from monetary policy reaction models

We investigate whether the ECB aligns its monetary policy with financial crisis risk in EMU member countries. We find that since the outbreak of the subprime crisis the ECB has significantly increased net lending and reduced interest rates when banking and sovereign debt crisis risk in vulnerable EMU countries (Greece, Ireland, Italy, Portugal, and Spain) increases, while no significant effect is identified for the pre-crisis period and relatively tranquil EMU countries (Austria, Belgium, France, Germany, and the Netherlands). These findings suggest that the ECB acts as a Lender of Last Resort for vulnerable EMU countries.

► We investigate whether the ECB aligns its monetary policy with financial crisis risk.
► We find more expansive monetary policy when sovereign and banking crisis risk rises.
► This effect is significant for vulnerable EMU countries during the subprime crisis.
► This effect is insignificant before the subprime crisis and for tranquil EMU countries.
► The ECB seems to act as a Lender of Last Resort for vulnerable EMU countries.