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May 23, 2014

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Posted: 23 May 2014 12:03 AM PDT

'A Note on the Lender of Last Resort'

Posted: 22 May 2014 09:49 AM PDT

Cecchetti & Schoenholtz:

A note on the lender of last resort: ...In responding to queries about the Federal Reserve's actions on the fateful Lehman weekend in mid-September 2008, various officials noted that the law does not allow the Federal Reserve to lend to an insolvent institution. As we reconsider the role of central bank lending, this is one principle, dating back to Walter Bagehot in the 19th century, that it is important to understand and maintain.
There are three big reasons that a central bank should not lend to a bankrupt institution. The first is that, by lending secured to an insolvent commercial bank, the central bank further subordinates bond holders. ... These actions pick winners and losers. In democracies, such choices are typically the prerogative of elected officials, not central bankers.
Second, lending to an insolvent institution by itself does not put an end to its fragility. Ultimately, the institution must be liquidated or re-capitalized. Postponing this resolution is usually costly. ...
Third, when people find out that the central bank is willing to lend to insolvent banks – and they will find out – then any bank that borrows will be suspected of being bankrupt. The resulting stigma will impair the useful function of the lender of last resort...
The real problem in 2008 was that there was no resolution regime in place that would allow ... big intermediaries to fail without disrupting the entire global financial system. ... Dodd-Frank ... created a new resolution mechanism... However, that regime ... remains untested...
Importantly, Dodd-Frank also narrowed the legal form of recipients eligible for Fed discount loans, contrary to the broad latitude suggested by Bagehot. ... Post Dodd-Frank, the discount window is for banks only. Others will have to seek liquidity elsewhere, even if they are solvent.

Unique Economics of Healthcare: Credence Goods

Posted: 22 May 2014 08:46 AM PDT

Cameron Murray:

Unique economics of healthcare: I was prompted to write this follow-up on health economics following a recent post by blogger Noah Smith, who weighs in with some reasonable views after some intense criticism of the 'freakonomic' Chicago-boy Steven Levitt. In a meeting with UK PM David Cameron, Levitt and his co-author apparently made some rather absurd remarks to him about health care.

They told him that the U.K.'s National Health Service -- free, unlimited, lifetime heath care -- was laudable but didn't make practical sense.  
"We tried to make our point with a thought experiment," they write. "We suggested to Mr. Cameron that he consider a similar policy in a different arena. What if, for instance...everyone were allowed to go down to the car dealership whenever they wanted and pick out any new model, free of charge, and drive it home?"
Rather than seeing the humor and realizing that health care is just like any other part of the economy, Cameron abruptly ended the meeting... 

This nonsense reminds me that what constitutes economic debate in the US is often laughable at best.

Health care is obviously not like most other parts of the economy. As I said last week medical services are credence goods - goods which we don't know whether we need, and even once we've consumed them, still don't know if they were good value. In economic terms, these goods suffer from the worse of possible information failures, particularly with respect to the asymmetry of information between the seller (in this case the doctor) and the consumer.

For these goods the demand curve may slope any which way, and people are often left to use price as the only signal of quality (or quantity for that matter). This means that a socially optimal level of medical service provision cannot be determined using basic marginal economic analysis. ...

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