On the subject of flood insurance…

3rd December, 2012

A loyal reader emails:

In the seminal Kydland and Prescott (1977) paper on time-inconsistency, they give this flood-related example:


The issues are obvious in many well-known problems of public policy. For example, suppose the socially desirable outcome is not to have houses built in a particular flood plain but, given that they are there, to take certain costly flood-control measures. If the government’s policy were not to build the dams and levees needed for flood protection and agents knew this was the case, even if houses were built there, rational agents would not live in the flood plains. But the rational agent knows that, if he and others build houses there, the government will take the necessary flood-control measures. Consequently. in the absence of a law prohibiting the construction of houses in the flood plain, houses are built there, and the army corps of engineers subsequently builds the dams and levees.

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