In today’s Financial Times, former U.S. Federal Reserve Chair Alan Greenspan opines that we can carry risk aversion too far. Greenspan’s discussion parallels that posted by Professor Gerard related to the interview of Vernon Smith. In particular, Greenspan argues persuasively that the more we set aside to protect against once in 50 year or once in 100 year adverse events, the less capital we have to devote to productive activities. He cites bank reserves in excess of $1.5 trillion as excessive private risk aversion. Regarding public policy, he argues as follows:
What is not conjectural, however, is that American policymakers, in recent years, faced with the choice to assist a major company or risk negative economic fallout, have regrettably almost always chosen to intervene. Failure to act would have evoked little praise, even if no problems subsequently arose; but scorn, and worse from Congress, if inaction was followed by severe economic repercussions. Regulatory policy, as a consequence, has become highly skewed towards maximising short-term bail-out assistance at a cost to long-term prosperity.
This bias leads to an excess of buffers at the expense of our standards of living. Public policy needs to address such concerns in a far more visible manner than we have tried to date. I suspect it will ultimately become part of the current debate over the proper role of government in influencing economic activity.