Concepts
Moral Hazard
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Moral hazard describes the tendency of a person or institution to take on more risk once they are protected from the full consequences of that risk, because someone else, an insurer, a guarantor, or a government, will bear part of the cost if things go wrong. The term originated in insurance, where a driver with full collision coverage might drive less carefully, but it applies widely across economics, including to banks that take on excessive risk when they expect a government bailout if they fail.
Facts
Origin YearThe word pairing itself is much older insurance-industry jargon, dated by Dembe and Boden's research to the 17th century and in wide use by English insurers by the late 19th century; 1963 marks its adoption as a formal economic-theory term, when Kenneth Arrow's paper on medical-care economics began the renewed economic study of the concept that continues today. SignificanceMoral hazard reasoning now applies far beyond its insurance-industry origin, including to why banks that expect a government bailout may take on excessive risk. 2 Disputed
Proposed ByDocumented in English insurance usage since the seventeenth century, long before any one economist; Kenneth Arrow's early-1960s work gave the term its modern, non-moralizing, information-asymmetry meaning in economics. Cross-Tradition Connections
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Why this is disputed. The 2008 bank bailouts renewed the moral hazard debate: some economists argued the rescues were necessary to prevent a deeper collapse of the financial system, while others argued they rewarded excessive risk taking and set a costly precedent for future crises.
Why this is disputed. IMF rescue lending to governments and central bank support for failing financial institutions are frequently analyzed through a moral hazard lens. Critics argue that expected rescues encourage excessive risk taking beforehand, while defenders argue that allowing a systemically important failure to proceed would impose far greater costs on the wider economy. Economists disagree about where this balance lies in practice.
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