Why Isn’t the Fed Tougher on Banks?

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I am live at The Washington Post‘s political science blog The Monkey Cage, writing about some of my recent research on the global financial system. One key bit:

[T]his result conforms to a simple logic: if you task central banks with financial stability, they will partially tailor monetary policy to make it so. If banks know that their central bankers have their interests in mind, they will behave with less prudence. It makes perfect sense why this would be the case. So long as banks do not violate their statutory capital requirements there is little that central banks can do to prevent this behavior even if they wished to do so. Economists refer to situations in which actors are able to shift the risk generated by their actions onto others as “moral hazard.” It is one of the greatest economic problems, which can cause entire markets to fail. Isn’t that what’s happening in this situation?

Read the rest here. The underlying research is available on my website here.

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