The Latest Literature
By Arnold Kling
The first three articles in the February 2012 issue of the American Economic Review are:
“Optimal Interventions in Markets with Adverse Selection.”
“Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning”
“Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts”
It seems that the point of each article is to provide a theoretical case that banking and finance are subject to market failures that can be corrected by government bailouts. The meta model for this literature might be this:
1. We know that government intervention addresses market failure.
2. Therefore, when we observe intervention, our task as economists is to reason backward to find the market failure that explains the need for the intervention.
Applying this meta model to the bailouts, our task is to develop formal mathematical models of what is intuitively grasped by policy makers like Henry Paulson. This may be a valuable line of research, but I hope that the literature will also consider possibilities outside of this meta model.