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Abstract

This paper analyzes dual liquidity crises, i.e. funding crises which encompass the private and the public sector, and the shock absorbing capacity of central banks within a closed system of financial accounts. We find that a central bank that operates under a flexible exchange rate is most effective in containing a dual liquidity crisis. A central bank of a euro area type monetary union has a similar capacity as long as the integrity of the union is beyond doubt. By contrast, within any fixed exchange rate system the availability of inter-central bank credit determines the elasticity of a central bank in providing liquidity. Finally, domestic constraints, i.e. collateral rules, risk taking ability or legal prohibitions, can limit the elasticity of the central bank's response to liquidity shocks.