Friday, March 15, 2013

A hesitant government may have good aspects

If you look at economic and especially fiscal policy in the US and in Europe these days, it can be characterized as hesitant. And this despite large challenges, or maybe because of these challenges as more is at stake and political forces dig in. It is widely regarded that a hesitant government is welfare worsening, but a case could be made for it to be welfare improving in situations where a the government lacks a necessary commitment device.

Jaromir Nosal and Guillermo Ordoñez discuss such a situation, namely bank bailouts. Quite obviously, the first best policy is to never allow bailouts, but once an opportunity arises, the government is much tempted to still use a bailout. This time-inconsistent policy translates into more risk-taking by banks, and more bailouts opportunities ensue. But if the government is hesitant, either because the information is not clear or because of internal or political constraints, then it does not authorize bailouts as easily, and banks behave better. Hesitating (or filibustering) acts like a commitment device. And this is good, in some situations.

No comments: