If a country were to make it compulsory to have airbags in every car, we would expect the number of fatalities to go down. Airbags are very effective in saving lives in case of a crash.

But according to a study called the Peltzman Effect, the introduction of safety features like Seatbelts and airbags don’t have a major effect in reducing fatalities. This is because people feel safer because of these features and drive with less attentiveness. Although the ratio of fatalities went down in accidents, the rate of accidents was found to rise enough to offset the decreased fatality rate. The net result is the fatalities are almost the same.

During the Global Financial Crisis, the US government decided to bail out the financial firms which were too big to fail for the sake of stability of the financial system and overall economy. These firms had taken an undue risk and ideally should have borne the result of the same. But the bail out has created a bad precedent or Moral Hazard. These firms now know that they are too big and important for the financial system. Incase, if a similar situation arises again they will be bailed out. This encourages excessive risk-taking.

Someday back I had written about the US Corporate Debt bubble. In order to save the wider US Economy, its central bank Federal Reserve has decided to support the US Corporate Bond market space. This again has created a moral hazard. This will again encourage excessive risk taking in the future.

Policymaking during a crisis isn’t easy. It’s all about choosing the lesser evil. The side effects of these medicines would stay with us for long.

When analysing any issue or decision, its important to consider the second order effects and unintended consequences.

Until then….

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