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Moral Hazard Misconceptions: The Case of the Greenspan Put

Gideon Bornstein and Guido Lorenzoni
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Gideon Bornstein: Northwestern University

IMF Economic Review, 2018, vol. 66, issue 2, 251-286

Abstract: Abstract 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.

JEL-codes: E44 E50 G18 (search for similar items in EconPapers)
Date: 2018
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