Brad DeLong's Dangerous Modeling
By Arnold Kling
From a short paper he calls Picking up Nickels:
The more speculators ex ante expect bailouts and the more speculators are impressed with their own cleverness, the more hesitant should the central bank be about providing monetary accommodation.
The paper comes very close to giving an Austrian account of business cycles, with part of the process consisting of the monetary authority keeping interest rates too low for too long. The paper comes close to saying that government bank policy creates moral hazard with adverse consequences. The paper comes close to saying that there is a major time inconsistency problem with bailouts–the incentive to bail out is stronger ex post than ex ante.The paper comes very close (more than close) to saying that we would be better off if the monetary authority did not try to eliminate all cyclical unemployment.
A little modeling can be a dangerous thing. Thanks to Mark Thoma for the pointer.