According to the financial instability hypothesis, when government intervenes to break a downturn
A)The economy returns to a financially stable position.
B)Spending units do not reduce their leveraging and the economy remains financially fragile.
C)the knowledge that the government will do so may create banks to take on more risks.
D)Both b and c are correct.

Question

Quizplus · Accepted Answer

The financial instability hypothesis argues that government intervention during downturns may actually promote financial fragility by creating a moral hazard. This means that spending units (e.g. banks and investors) may feel incentivized to take on more risks because they believe the government will bail them out if things go wrong. Therefore, both choice B (spending units do not reduce their leveraging and the economy remains financially fragile) and choice C (the knowledge that the government will intervene may create banks to take on more risks) are correct.

According to the Financial Instability Hypothesis, When Government Intervenes to Break