Describe how the lender-of-last-resort function in central banking might cause a moral hazard problem that affects the lending and investment behavior of financial market participants.

Given that the entity is under the impression that they are shielded by a federal bank which has the possibility of getting them out of trouble and knowing that they have the ability to borrow from the federal bank every time they feel the need to since the federal bank cannot allow for their failure, there is a likelihood of the entity to be more reckless and careless in their lending and investment patterns and behavior.

This might result in an increase in the lending clause to businesses and individuals who tend to be risky. In instances where a crisis is caused here, it can result in a recession similar to the one that occurred in the case of the subs prime crisis in the United States. This will eventually cause the investment and lending to fall further as a result of market sentiment going down.