Moral Hazard at the Central Bank Level
Define Moral Hazard We know that there is an incentive for firms that are either too important or ‘too big’ to fail, to act wrecklessly because they know that they will get bailed out. Whether the individual is a highly trained, very unique doctor like House, or a bank/financial institution that is too important to the system to fail. Often times, their wreckless actions puts the regulators or people responsible for them in a precarious situation where they have to bail them out or save them. What about the central banks though? In a world where financial institutions all over the world are as interconnected as financial institutions in the same neighbourhood, how do we decide which central bank should do the heavy lifting? It is no secret that if the Fed didn’t take some of it’s extraordinary measures the financial system would have imploded. That is no longer debateable. The question is, why aren’t other central banks ignoring ‘self-interest’ agendas and cooperating with the whole system. Jean-Claude Trichet (check spelling) has taken a hard nosed stance against Fed type bailout actions. The irony though is that the only reason he can do that, is because Bernanke has already done the heavy lifting. Had bernanke not done what he has done to date, then surely at the very least the ECB and Bank of Japan and other central banks would have had to do some of the lifting. So by Bernanke doing what he did, he created a Moral Hazard for the other central banks - because now they can act out of their own self-interest - because they know the entire house won’t collapse. Bernanke acted on behalf of the house. Trichet is acting on behalf of his floor. All in all, can Moral Hazard be completely eradicated/defeated in today’s integrated global economy?