Blinder’s Dutch boy story retold

Kansas Fed Symposium papers have been put on the website. The conference going by its tradition has led to couple of superb papers. The paper which has led to most controversy is the one by Willem Buiter (a 141 page paper!!) and the discussion of the paper by Alan Blinder. Buiter thrashes Fed and Blinder defends it. I haven’t read Buiter’s paper (of course) and just read Blinder’s paper.

In this post, I would like to restate Blinder’s story of the Dutch Boy. Blinder’s version is:

One day a little Dutch boy was walking home when he noticed a small leak in a dike that protected the people in the surrounding town. He started to stick his finger in the hole, but then he remembered his moral hazard lesson. “The companies that built this dike did a terrible job,” the boy said. “They don’t deserve a bailout. And doing that would just encourage more shoddy construction. Besides, the dumb people who live here should never have built their homes on a floodplain.” The boy continued on his way home. Before he arrived, the dike burst and everyone for miles around drowned, including the little Dutch boy.

Perhaps, You’ve have heard Fed’s an alternative version of this story. In this kindler, gentler version, the little Dutch boy, somewhat desperate and very worried about the horrors of the flood, stuck his finger in the dike and held it there until help arrived. It was painful. The little Dutch boy would much rather have been somewhere else. But he did it anyway. And all the foolish people who live behind the dike were saved from the error of their ways.

Here is my version of the story:

The little Dutch boy, somewhat desperate and very worried about the horrors of the flood, stuck his finger in the dike and held it there until help arrived. 

Meanwhile as the help too time to arrive, he remembered and wondered why such dikes keep being built. He had heard stories of such dikes being made time and time again and someone finding it and sticking his finger. Sometime the dikes were quite weak and the finger didn’t work and drowned everybody despite the best effort.  He had also heard the persons who built the dikes did not usually suffer as they had received the money and were building dikes elsewhere or enjoying the pay-offs (building their own castles away from the dikes).  He had even heard that if the flow of water was very strong it could destroy other dikes as well leading to big deluge. This made him nervous and wanting to withdraw the finger.

Then he also remebered, the dikes that were stronger and the finger helped, the person was hailed as a hero. So he just stuck it on hoping his dike is stronger.

Despite all this confusion, he kept thinking why the dikes kept on being built in such a manner….. He then related the problem to his school and realised that whenever he (or orhers) was punished he did not make the same mistake (or atleast tried his best to aviod it). So why did the dike buuilders not get punshed enough not to repeat the mistake again?

While thinking all this, the dike turned out to be weaker than expected….

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