Moral hazard is back on the agenda; should central banks cave to markets?
Markets are pretty good at bullying monetary authorities
El-Erian argues for a more aggressive stance like that of Paul Volcker, who slew inflation using high rates, even though it provoked a recession:
The system needs a Volcker moment, one similar to the early 1980s, when as head of the Fed, he boldly sought to and succeeded in breaking inflation’s grip on the economy, which also contaminated mindsets.
What is needed now is to break the de facto ability of markets to bully central banks.
What El-Erian is describing here is moral hazard — the lack of incentive to guard against risks if you are confident that someone will bail you out from the consequences.
It’s arguably an inevitable feature of fiat currencies, and it’s not new.
The greatest attempt to slay moral hazard backfired.
Letting Lehman Brothers fail in 2008 was meant to show the markets who was boss.
Instead, it soon became clear that the financial system was close to disaster and that regulators could not possibly allow another major institution to go down.
Yhe Christmas Eve Massacre
It was the bond vigilantes who doused the enthusiasm Wednesday as a poorly received Treasury auction sent yields upward again.
The Moral Hazard Paradox of Financial Safety Nets
UC Law, San Francisco Date Written: March 18, 2015
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2580062
John Authers Bloomberg 8 August 2024
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