They can only eliminate the moral hazard problem by being able to commit to NOT intervening. If they “might” intervene businesses will put some probability on it.

As a result, they can state that the tail probability of a bailout is lower than businesses implicitly expect – implying that telling people directly what the parameters are reduces the amount of moral hazard activity.

“Another consideration may be the form of a bailout. A bailout that involves nationalising a company (not that I favour this option) and replacing senior management is surely not desirable for any executive”

Indeed, the form of the bailout and the balance of control in an organisation are other essential issues that need to be taken into consideration when deciding on policy. However, I think this is why certainty of any bailout is so important – as it definitively structures it in the best way prior to any crisis.

This was my point, by being so vague, they would almost eliminate the moral hazard problem.

Another consideration may be the form of a bailout. A bailout that involves nationalising a company (not that I favour this option) and replacing senior management is surely not desirable for any executive.

In this kind of situation most companies would have to operaoe under the assumption that they aren’t (expect for Air NZ and Fonterra) which is porbably a good thing.

Simply say if there are any bailouts, it will only be where the government considers it necessary for the overall health of the economy. A statement like that means businesses can’t expect to be bailed out but it still allows the government to help out in a market failure.”

Necessary is quite a subjective term that in itself implies a threshold – if you make what is “necessary” explicit then firms and households have more certainty when making decisions.

Note, being able to commit to a higher threshold to bailouts would actually reduce moral hazard compared to the current “implicit” policy.

Simply say if there are any bailouts, it will only be where the government considers it necessary for the overall health of the economy. A statement like that means businesses can’t expect to be bailed out but it still allows the government to help out in a market failure.

I guess the risk could be:

– if you are going to f*ck things up, you should f*ck things up to a big degree 😉

As a result, the magnitude of the “bailout” will matter as well.

No-one wants uncertainty – which is why a transparent threshold for bailouts should be set, if the government feels that there are situations where they can help.

The issue at the moment is that government can’t seem to commit to any set level – they act like they will do nothing, but then when anything happens they run around like a headless chicken (hence why so much of the US policy is currently termed ad hoc). This is a bad thing.

This doesn’t mean that a pre-determined bailout threshold could be a bad idea (it doesn’t mean it could be a good idea either) – but it does mean that governments ability to commit itself to a certain action plan hurts a nations welfare.

Government needs to learn to see itself as a structural variable – they need to set transparent rules that occur. However, the political process rewards constant “change” and “trying to do things” – exactly the sort of variability you don’t want in the structure of the economy during a time of uncertainty 🙂