Moral Hazard

A situation where individuals, firms, or governments take too much risk because they expect to receive help if they get into trouble.

The U.S. government bailed out several banks during the global financial crisis. Other banks could draw the conclusion that they would also receive help if they ask. Therefore, the banks could decide to make risky loans at high interest rates. If the loans turn out OK, then the banks win. If the loans turn out bad, the government (the taxpayers) loses.

The same could occur on the country level. If a government expects to be bailed out by the International Monetary Fund, it may decide to borrow more money than it should from the international capital markets.

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