Moral Hazard Misconceptions The Case of the Greenspan Put

Policy discussions on financial regulation tend to assume that whenever a corrective policy is used ex post to ameliorate the effects of a crisis, there are negative side effects in terms of moral hazard ex ante. This paper shows that this is not a general theoretical prediction, focusing on the cas...

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Bibliographic Details
Published inIMF economic review Vol. 66; no. 2; pp. 251 - 286
Main Authors Bornstein, Gideon, Lorenzoni, Guido
Format Journal Article
LanguageEnglish
Published London Palgrave Macmillan Journals 01.06.2018
Palgrave Macmillan UK
Palgrave Macmillan Ltd. (Springer)
Palgrave Macmillan
Subjects
Banking
Capital Markets
Central banks
Economic models
Economic Policy
Economics
Economics and Finance
Environmental policy
Interest rates
International Economics
Intervention
Laws, regulations and rules
Macroeconomics/Monetary Economics//Financial Economics
Monetary policy
Moral hazard
Powers and duties
Predictions
Prices
Regulation of financial institutions
RESEARCH ARTICLE
E44
E50
G18
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Summary:Policy discussions on financial regulation tend to assume that whenever a corrective policy is used ex post to ameliorate the effects of a crisis, there are negative side effects in terms of moral hazard ex ante. This paper shows that this is not a general theoretical prediction, focusing on the case of monetary policy interventions ex post. In particular, we show that if the central bank does not intervene by monetary easing following a crisis, an aggregate demand externality makes borrowing ex ante inefficient. If instead the central bank follows the optimal discretionary policy and intervenes to stabilize asset prices and real activity, we show examples in which the aggregate demand externality disappears, reducing the need for ex ante intervention.
ISSN:2041-4161
2041-417X
DOI:10.1057/s41308-018-0052-x