More is Less? Market Maker of Last Resort and Its Fragility

We provide a model for the market maker of last resort (MMLR) role of central banks that received much attention recently. MMLR intends to provide a backstop to restore market confidence and liquidity by promising to acquire assets if needed. Central bank announcement to provide liquidity in times of distress promotes private agents' willingness to make markets, which immediately restores market liquidity to prevent disorderly sales. This, in turn, decreases the future need for the central bank to intervene. We show that the central bank can reduce the expected usage of the facility by announcing a large capacity, that is, it can end up doing less ex post by committing more ex ante. However, this comes with potential fragility due to the possibility of multiple self-fulfilling equilibria. Central bank may not achieve the intended outcome if it cannot intervene at a large enough scale or if market participants have doubts about its commitment.