Thursday, September 27, 2007

Moral Hazard

It's fascinating to me to read about whether lower fed discount rates cause inflation, and even whether it's good for the stock market. I wish I'd blogged on it last week, because there was great article that basically said we have no idea how the economy really works. We understand some things, for example, a smaller discount rate immediately increases the value of stocks. When the discount rate was lowered, the NPV of all stocks immediately rose, if you assume that the value of a stock is actually correlated to the company's ability to generate free cash flow (if it isn't, then the stock market must be a form of gambling). But we don't understand the long term effects of such changes. There is no shortage of experts willing to write about whether this is good or bad. But I really enjoyed this one:, which has some great quotes and concerns. If indeed, past irresponsible behavior could lead to pain for millions of people, the discount rate simply had to be cut. The question is, how do we know that is the case? We may very well have increased our risk.

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