Discussion on the role of public institute in the financial system first started with the formation of economics in the 19th century and is still on going. Around the 1960s, the discussion mainly focused on the monetary policy, but in recent years, the focus has been moving towards the functions of public institutions relating to risk management or lender of last resort, as inflation stabilized in recent years but the occurrence of financial crises is frequent since the growing trend of financial liberalization.
Today, three opinions, ‘market failure,’ ‘central position,’ and ‘free banking’ are being confronted. An interesting fact from the discussions among the three opinions is that they all have their theoretical roots in Lombard Street: A Description of Money Market (1873) by Walter Bagehot, a British economist in the late 19th century. For this reason, the interpretation of this book is often the target of their discussions, which implies that correct understanding of this book could offer some help in judging
which opinion is better or more accurate than the others. This also is the motive of this research.

The methodology that this research had adopted for better understanding of Bagehot’s lender of last resort theory is to analyze the historical space where Bagehot had belonged. To understand Bagehot, it is necessary to know the changes and subsequent problems the then British financial system had. To that end, the paper first monitors the environmental changes in the financial economy of the mid-19th century. Two changes this paper gives a particular attention to are the vitalization of liberal movement of
international capital and the advent and expansion of deposit banking system based on the factional reserve system. Because of these changes, the UK became the first to experience the internal and external instability of finance. There occurred frequent financial crises related to the instable international capital movement and large swings in business cycle related to the instable supply of domestic fund flow. Accordingly, then economic experts in the UK began to seriously consider the setup of monetary policy
to sustain economic stability and financial measures to counter financial crises under the domestic and foreign financial order of liberal creation and transfer of liquidity. This is the interpretation of this paper.

Facing these policy agenda, then economic experts suggested two conflicting opinions, one from the Currency School, the other from the Banking School. The winner of the discussion was the Currency School, and their opinions were incorporated into policy. They considered that at the bottom of the money supply shock lays financial crisis and a business cycle that includes the crisis. The excessive note issuance by the Bank of England (BOE) and local banks caused bubbles and its aftereffect was a financial crisis,
according to the supporters of the Currency School. In this context, they suggested as a best solution strict standards for the creation of liquidity by banks including the BOE. The significant reason that the Currency School opinions were dominant was believed to be that they well satisfied critical minds of then economic experts relating to the core problems. The UK, between the late 18th and 19th centuries was undergoing a transitional period from the metallic currency system—where gold or silver coins were
used as currency—to the mixed currency system—where gold coins and paper currency based on bank notes and deposit currency were simultaneously used.

The Currency School considered it most necessary to impose monetary discipline as the regulative measures to the creation of liquidity in any form in order to sustain the economic stability under the new economy trend. In addition, the Currency School’s mechanical argument on monetary policy theory was suggested not because they did not recognize the necessity of the function of the lender of last resort. The Currency School was already aware of the dynamic time inconsistency problem which is popularly understood
today. They thought, the moment when the Article of granting the application of bank note issuance rules in panic situation moral hazard could follow, threatening the establishment of the monetary discipline. In this regard, they believed that the answer to the problem of dynamic time inconsistency was a structure whose fundamental factor should be based on the ‘legislation of the currency policy rules without making conditions on exceptional cases in advance, and under which the policy authority exerts its
direct discretionary power under the surveillance of the legislator, the National Assembly, in responding to exceptional cases that require the application of the law. However, as it became legislated, the theoretical system of the Currency School had shown weaknesses that were evident. The problem of the importance of the deposit currency and the endogeneity of currency were supposed to occur in a later time, but the problem of financial crises and the exhibition of the lender of last resort function were realized
right away. Faced with the series of financial crises in 1847, 1857, and 1866, the responses of the EOB disappointed a number of people. The EOB did not expand the liquidity supply earlier, and at the last minute,  the paralysis of the financial system was evident, the application of the law was suspended momentarily and the issuance of bank notes was expanded. The EOB’s expansion of liquidity supply worked to stabilize the crises, but an increasing number of people began to believe that the EOB’s responses
were not satisfactory. So far is the historical progress until 1873 when Bagehot wrote Lombard Street. For Bagehot, the most significant policy impression of the changes in the financial environment was the rise in the risk of financial crisis caused by panic. In particular, he emphasized the integration of the international capital markets and warned of the foreign exchange crisis brought on by the changes in credit rating and the subsequent risk of financial crisis. Bagehot’s recognition of higher risk of
the panic-caused financial crisis due to the changes in the financial environment, though stronger recognition, was not different from that of the Banking School, and the Currency School had not denied the risk. Not only that, Bagehot diagnosed that the application of the solution of the Currency School resulted in significantly weakening the UK economy’s risk management or the lender of last resort function. This diagnosis was already pointed out by the Banking School, but the difference in the Bagehot’s argument
was a completely new analysis method he used for the diagnosis. The responsive solution to the financial crisis supported by the Banking School was to tacitly let the government’s discretional authority handle the crisis. Bagehot argued that this solution triggered uncertainty and worked to aggravate the financial crisis, rather than stabilizing the panic-caused financial crisis.

The ‘tacitness’ and ‘uncertainty’ of the ‘dynamic time inconsistency’ by the Currency School might be able to mange the risk in the end, but Bagehot believed that during that process, the solution could expand the crisis risk while further increasing the cost of risk management. Based on this belief, Bagehot suggested new policy measures, which offered transparent policy goals and reform in the governance structure of the EOB. If the premise is that the EOB should aim at two goals of imposing currency
discipline and playing the role of risk management or lender of last resort, it is theoretically possible that pursuing these two could cause the ‘dynamic time inconsistency’ problem as the Currency School emphasized. However, the modern economics, since the 1980s found that if the goals of the policy authority are made clear for the general public to understand, the ‘dynamic time inconsistency’ problem could be solved by reputation. If this reputation mechanism works, it could bring far better outcomes in
the environment with higher uncertainty, compared to the standard solutions that significantly weaken the flexibility of exerting the discretionary power. This problem solving by the ‘reputation’ mechanism is what Bagehot suggested.

This study’s interpretation of lender of last resort by Bagehot is consistent with Bagehot’s interpretation of ‘market failure—one of the three modern economic theories. In that sense, Bagehot believed that the characteristics of financial market are difficult to explain with the perfection, and the rationality of the market constitutes an important part and that his perspective can be understood as the same with the market failure perspective. The same goes for his perspective that under the financial
environment ruled by uncertainty, the responsive instrument to deal with the panic-caused financial crisis should be implemented by allowing the relevant authority to exert their own discretionary power in principle but solving problems of moral hazard should be tried through the establishment of incentive structure.

Lastly, this study comments on the modernity of Bagehot’s argument. Bagehot is conveying two messages to people of today. First, under the environment where domestic financial market is liberalized and global capital market is integrated, the risks of the panic-caused foreign exchange crisis and the financial market co-exist. Second, in principle, dealing with such risks, the discretionary power of the policy authority should be guaranteed and the possible abuse of the power should remain controlled by the
reputation mechanism. In relation to this, Bagehot particularly emphasized that the authority holding the responsibility should be clearly identified, the operation of this authority should not be distorted by private and political interests, and its governance structure should be carefully designed to maintain its specialty and sustainability.

제1장 서 론

제2장 Bagehot 최종대부자론의 세 가지 해석
　제1절 Bagehot의 서술
　제2절 세 가지 해석
　　1. ‘중도 견해’의 해석
　　2. ‘시장실패 견해’의 해석
　　3. 자유은행론자로서의 Bagehot

제3장 Bagehot의 진의
　제1절 19세기 영국 금융시스템의 환경변화
　　1. 19세기 영국 금융시스템의 환경변화
　　　가. 국제자본시장의 통합
　　　나. 유동성 창출 금융기관의 등장
　　2. 제기된 문제
　제2절 Bagehot 이전의 두 가지 해답: ‘통화학파’와 ‘은행학파’
　　1. ‘통화학파’와 ‘은행학파’의 기본 주장
　　2. 논쟁의 평가: 통화학파 이론체계의 이해
　　3. 제도와 경제의 전개과정
　제3절 Bagehot의 문제와 진의
　　1. Bagehot의 문제
　　2. Bagehot의 해법
　　3. Bagehot의 진의
　　　가. ‘시장실패 견해’로서의 Bagehot
　　　나. Bagehot와 19세기 영국 금융경제학

제4장 결 론

참고문헌