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Wednesday, May 4, 2011
What is regulation?
I keep thinking about last night's debate. You all struggled with the lack of absolutes: policy responses are not right or wrong as much as better and worse. The lack of definitive data led you to argue theory against value. But I'm left with some questions that I will be asking you this week. The first concerns regulation, deregulation, and efficiency. From your perspective, what is inefficient regulation? What would be an example? Is there efficiency-improving regulation? If so, what?
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I think that there are three major types of regulation that would be smart to look at.
ReplyDelete1. Smaller bank sizes
2. Less complex financial products
3. More strict capital requirements
The first would increase competition, and not only would it reduce monopoly power in the industry, it would also reduce the political power of Wall Street in Washington.
The second, very simply, would make information less imperfect for consumers.
The third is more nuanced. In the short-run, this regulation is less efficient. In the long-run, when we account for the huge set back to the economy that come from lack of regulation, however, this regulation increases efficiency.
I agree with some of the things Dane said, but I want to add a few things.
ReplyDeleteSystemic Risk (i.e. a cascading effect when one bank fails, others tend to do the same) is a huge reason we need to find appropriate types of regulation. The simple fact that a failure in Lehman Brothers (ex.) will bring about huge difficulties for other banks is troubling.
The other things I would like to see regulated is the leverage that banks are allowed to employ. When banks are allowed to leverage their capital to the umpteenth degree, minor financial instability could bring about monumental crashes.
Lastly, and I don't know how to regulate this, but the moral hazard issue is troubling to me. There are all kinds of moral hazard in the banking industry, and it just seems to me that banks will employ riskier strategies if it isn't their money they stand to lose. I have no idea how to correct this though.
Aside from eliminating monopoly power I think all regulation can be considered inefficient. Friedman economics supports this. Unfortunately, asymmetric and incomplete information, moral hazard, and irrationality decrease what would be in my mind efficient markets. Thus, I think there is a strong case to be made for a need for regulation, but only to the extent that it attempts to eliminate these market inefficiencies.
ReplyDeleteI am still a major proponent of free markets and competition as I think it leads to the greatest levels of innovation and economic growth, but despite how advanced technology and financial market workings are today their still exists inefficiencies which I believe regulation TO AN EXTENT can cure.
Just for clarification, when I said more strict capital requirements, I was advocating for regulation of leverage..
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