Moral Hazard Misconceptions: the Case of the Greenspan Put
Policy discussions on financial market 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, this creates an aggregate demand externality that 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.
Document Object Identifier (DOI): 10.3386/w24050
Published: Gideon Bornstein & Guido Lorenzoni, 2018. "Moral Hazard Misconceptions: The Case of the Greenspan Put," IMF Economic Review, vol 66(2), pages 251-286. citation courtesy of
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