When the Federal Reserve called a halt to interest rate rises and signaled an end to the long term reduction of the $4 trillion in assets it acquired on its balance sheet during the Great Recession, it tacitly admitted that the nation is woefully unprepared for the next recession. With few policy tools in hand, it is essential that the government add some new ones.
Consider, for example, law and regulation. To illustrate why we should turn to law, let me explain why our current policy tools will not work here. The Federal Reserve called an end to its series of short term interest rate hikes at a rate of 2.5 percent, which means that these rates can only be cut by that much before they run into the zero lower bound. In past recessions, the Federal Reserve had to cut rates by much higher percentages to restore the economy to health. Ordinary stimulus is therefore unlikely to meet our needs the next time the nation hits a drastic decline.
At the zero lower bound, the Federal Reserve can turn to quantitative easing, lowering long term interest rates by buying trillions of dollars in long term bonds. But this time, the Federal Reserve will be starting with a hangover of trillions of dollars from the multiple rounds of quantitative easing it conducted in response to the Great Recession. Another round of quantitative easing likely means a central bank balance sheet in the tens of trillions of dollars. Fears of asset bubbles and calls to audit the Federal Reserve, already widespread, would increase dramatically.
Fiscal stimulus is the obvious alternative to monetary policy, as debt spending and tax cuts boost a weak economy even when interest rate cuts cannot. With our boom time national deficit approaching 4 percent after enacting the budget busting Tax Cuts and Jobs Act, however, there is not much room left for such a strategy. Moreover, it is reckless to count on timely fiscal stimulus during this era of Washington gridlock.
So what should we do? This is where law comes in as the unorthodox solution that just might save us from the economic downturn hovering on the horizon. While law was the primary tool of macroeconomic policy during the Great Depression, it has been forgotten in the recent past. Adjusting law and regulation for the business cycle offers a stimulus free of the albatrosses associated with fiscal and monetary policy.
Zoning law and utility regulation offer two promising examples of what I call “expansionary legal policy.” If zoning restrictions were looser for buildings constructed during recessions, developers would have an incentive to begin projects instead of waiting for better times. It is like an infrastructure stimulus plan without the need for government spending. Moreover, because zoning boards enjoy considerable discretion to award zoning variances in “hardship” cases, they can provide legal stimulus without having to go through such a tortuous legislative process.
Similarly, if our utility regulators held electricity and other utility prices down during recessions and allowed for higher prices during booms, consumers would have more money to spend when money is tightest. This policy mimics a tax cut during recessions, with the debt paid back during periods of more robust growth. This type of spending boost does not require legislative action, just a broader definition of the timeline in which utility investors need to earn a competitive return. Instead of giving investors a nearly fixed return every year, utility regulators should promise adequate returns over the entire course of the business cycle.
These are just a few of the myriad possibilities. Law affects nearly every aspect of economic life. If we adjusted many of our laws to encourage spending during downturns, then spending would almost certainly increase. Moreover, because this increase comes from the private sector, expansionary legal policy does not swell government deficits, nor does it require ever more aggressive and improvised tactics from overmighty central banks. Expansionary legal policy is unconventional, but it is our best bet for dealing with the economic crisis that lies ahead.
Yair Listokin is the Shibley Professor at Yale Law School and the author of the new book “Law and Macroeconomics: Legal Remedies to Recession.”