Ben Bernanke Explains Systemic Risk
By Bryan Caplan
Last week, Arnold approvingly quoted Tyler’s one-sentence explanation of “systemic risk”:
If your banks are less risky, often something else is more risky, and vice versa.
This morning it just occured to me that this is precisely the opposite of what Ben Bernanke taught me. Assuming my memory doesn’t fail me, Bernanke’s one-sentence explanation of “systemic risk” was basically:
If your banks are less risky, often something else is less risky, and vice versa.
The claim, in other words, is that bailing out a failing sector is supposed to make failure in other sectors less likely.
As far as I can tell, Bernanke’s explanation is the standard one. It’s also an internally consistent story about why bail-outs are better than they seem. If you bought Tyler’s version, though, systemic risk would be a story about why bail-outs are worse than they seem – when you help banks, you’re hurting other sectors, which will in turn need bail-outs of their own. Am I missing something?