The essential guide to Moral Hazard in Economics

Examples of Moral Hazard

In the context of central banks printing ever more money to save businesses at any cost, there are several moral hazards at play:

1. Encouraging excessive risk-taking: When central banks signal that they will bail out businesses no matter what, it may encourage firms to take on excessive risk, as they believe they will be protected from the negative consequences of their actions. This can lead to a misallocation of resources, as capital is directed to less efficient or less deserving projects. In the long run, this can have negative implications for the overall health of the economy.

2. Distorting market signals: Central banks’ actions to save businesses may distort price signals in financial markets, as the risk of business failure is not accurately reflected in asset prices. This can lead to an overvaluation of assets and encourage further speculative activities, increasing the likelihood of financial instability and potential crises.

3. Undermining market discipline: In a healthy market, inefficient or poorly managed businesses fail, making room for more efficient competitors to grow. By bailing out businesses indiscriminately, central banks may undermine this natural selection process, resulting in a less competitive and less innovative market.

4. Financial institutions taking excessive risks can contribute to the build-up of systemic risk in the financial system, as banks become more interconnected and more vulnerable to shocks.

5. Inflation and distributional effects: Printing large amounts of money can lead to inflation, which erodes the value of money and disproportionately affects lower-income individuals, as they tend to hold more of their wealth in cash. Additionally, inflation can cause distortions in the economy and make it more difficult for businesses and households to plan for the future.

6. Eroding public trust: Finally, by repeatedly intervening to save businesses, central banks may erode public trust in their ability to maintain financial stability and protect the value of the currency. This can have long-term implications for the credibility of monetary policy and the central bank’s role in the economy.

History of the term ‘Moral Hazard’

The term “moral hazard” originally emerged in the context of maritime insurance during the 17th century. It referred to the change in behaviour by insured ship owners who engaged in riskier activities knowing that their potential losses would be covered by insurance companies. 

Over time, moral hazard became increasingly recognized as an inherent challenge within the insurance industry as insurance products for life, health, fire, and other risks became more common in the 18th and 19th centuries. In the 20th century, the concept was integrated into economic theory, and the implications of asymmetric information in markets were studied. 

Later, moral hazard became a prominent topic in financial markets particularly in the context of bank regulation, government bailouts, and central bank interventions, as economists like Paul Krugman and Joseph Stiglitz emphasized the importance of understanding the incentives and risks involved in financial decision-making during crises.

Why Moral Hazard is a problem and how gold can protect you

Moral Hazard is an important concept for understanding how the presence of insurance or other forms of risk protection can change the behaviour of individuals, firms, or governments, leading to potentially negative outcomes. 

Financial moral hazard relates to central banks printing ever more money to save businesses at any cost can lead to excessive risk-taking, market distortions, and a lack of market discipline. It may also contribute to inflation, negatively impact income distribution, and undermine public trust in the central bank.

Gold, on the other hand, is a precious metal that has been used as a store of value and a medium of exchange for thousands of years. Its nature cannot be changed, and it cannot be printed, it is not a financial instrument or a form of currency that can be subject to moral hazard. You can use Glint to buy, save, send and spend physical gold as everyday money, effectively putting yourself onto your own personal gold standard and protecting yourself from some of the moral hazards prevalent in society. 

Useful sources of information on Moral Hazard:

Here are some reputable sources that have informative content on moral hazard:

1. Investopedia – Moral Hazard:
This page provides an overview of moral hazard, its implications in various sectors, and examples to help you understand the concept better.

2. The Political Economy of Moral Hazard:
This resource provides a more in-depth understanding of moral hazard, including conventional theory, its impact on the free market and the monetary system.