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Recession Insurance

NEW HAVEN – The Chief Economist of the International Monetary Fund, Olivier Blanchard, and several IMF economists have proposed in a recent paper that governments should offer what they call “recession insurance.” Companies and/or individuals would buy insurance policies, pay a regular premium for them, and receive a benefit if some measure of the economy, such as GDP growth, dropped below a specified level. Such insurance, they argue, would help firms and people deal with the “extreme uncertainty” of the current economic environment.

Recession insurance might, indeed, help alleviate the economic crisis by reducing uncertainty. After all, the real problem that we are currently facing is one of paralysis: uncertainty has placed many spending decisions – by businesses (on higher output) and by consumers (on the items that businesses produce) – on hold. Reducing uncertainty might augment, or even be superior to, fiscal stimulus programs, for it would address the root cause of the unwillingness to spend.

Moreover, recession insurance might, in contrast to fiscal policy, impose no costs on the government, for if it stimulates confidence, then the risk being insured against is prevented. The government’s ability to offer such insurance on a scale sufficient to make it costless is one reason to favor a public scheme over private insurers.

Blanchard and his colleagues point out that banks might condition loans to firms on their purchase of recession insurance, which might help credit markets function better, addressing a serious problem underlying the current crisis. Tantalizingly, they say that doing this would create “a market-based view of future output and the likelihood of severe shocks,” although they do not explain how this market would be structured.