He and Nouriel Roubini were both interviewed at CNBC recently, but soundbite journalists are incapable of handling their views sadly.

Yes, but risk averse banks will now have an incentive to give out loans with a higher ex-ante variability in outcomes (higher risk), as their downside is covered – this is the moral hazard problem, and it exposes society to these risks (when they are risk averse) which has a welfare cost.

Or more formally, is a production subsidy to a monopolist welfare-enhancing? I can’t remember.

The banks will be willing to loan to a riskier pool of borrowers based on the fact that their downside risk is covered – won’t they?

“Isn’t the real moral hazard channel on the borrower side”

Indeed – it is on their side as well, good point.

Still, I not convinced that this is really a moral hazard situation as you describe it. The banks are largely being hit by credit market problems not of their making, the only way they could have avoided the problems is by funding all mortgages out of domestic savings (which would require much higher interest rates). There is no suggestion as of yet that bank capital levels are inadequate.

Isn’t the real moral hazard channel on the borrower side? People can take out excessive mortgages, knowing that the housing sector has too large an impact on the NZ economy for the RBNZ to allow interest rates to rise too high, or allow house prices to fall to far.

I agree that exporters are probably feeling peeved right now though, even if the RBNZ’s actions are justifiable.