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Saturday, August 23, 2008

The Little Dutch Boy

Alan Blinder explains:

A Misguided Federal Reserve, or One That Saved the Day?, by Sudeep Reddy, WSJ Economics Blog:  The most controversial presentation at the Kansas City Fed’s annual symposium came from ... Willem Buiter. ...

Mr. Buiter slams the Federal Reserve, European Central Bank and Bank of England for what he says was a mishandling of the financial crisis and monetary policy over the past year. He gives the worst markets to the Fed...

Few participants at the Jackson Hole event appeared to support Mr. Buiter’s view. Even those displeased with some specific Fed actions probably back the Fed’s overall approach: trying to tackle the financial crisis to prevent much deeper trouble in the wider economy.

Assigned the task of critiquing the paper was Alan Blinder, the former Fed vice chairman, who gave high marks to the central bank. Mr. Blinder brought his point home to the crowd with a tale of a little Dutch boy (Mr. Buiter was born in the Netherlands), entertaining the crowd of international central bankers, academics and Wall Street economists:

One day a little Dutch boy was walking home when he noticed a small leak in a dike that protected the people in the surrounding town. He started to stick his finger in the hole, but then he remembered his moral hazard lesson. “The companies that built this dike did a terrible job,” the boy said. “They don’t deserve a bailout. And doing that would just encourage more shoddy construction. Besides, the dumb people who live here should never have built their homes on a floodplain.” The boy continued on his way home. Before he arrived, the dike burst and everyone for miles around drowned, including the little Dutch boy.

Mr. Blinder continued: “You might have heard an alternative version of this story circulating around the Fed.”

In this kindler, gentler version, the little Dutch boy, somewhat desperate and very worried about the horrors of the flood, stuck his finger in the dike and held it there until help arrived. … It was painful. The little Dutch boy would much rather have been somewhere else. But he did it anyway. And all the foolish people who live behind the dike were saved from the error of their ways.

    Posted by on Saturday, August 23, 2008 at 05:04 PM in Economics, Market Failure, Monetary Policy | Permalink  TrackBack (0)  Comments (34)

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