Should Regulation Be Countercyclical?

Can regulation be used as a macroeconomic policy tool? That is, when agencies regulate, should they consider the effects of their regulations on the labor market and the economy as a whole? We take up this question in a new paper titled Should Regulation Be Countercyclical?, written for an upcoming conference on Law & Macroeconomics. There is historical precedent for thinking of regulation in macroeconomic terms. In 2011, the Obama administration withdrew a proposed Environmental Protection Agency rule which would have strengthened the National Ambient Air Quality Standards for ozone. The White House explained that, while it supported stronger environmental regulations, it was unwise to push ahead with them during a weak economic recovery because of their possible adverse effects on job growth. It promised to revisit the issue in 2013, and in 2015 the Obama administration finally issued a stricter ozone rule, in a healthier macroeconomic environment.

While many people saw an unwelcome intrusion of politics into the rulemaking process, we are interested in evaluating the White House’s policy justification for the delay. The suggestion is that the ozone rule would have increased unemployment in 2011, while it would not have increased unemployment in 2015 or would have done so only modestly and at lower social cost. What is interesting about this argument is that it is a macroeconomic argument relating to the timing of regulation. Many economists believe that the government can stimulate the economy during a recession by lowering interest rates, cutting taxes, or increasing government spending. Because regulations are functionally very similar to taxes, this argument might imply as well that the government can stimulate the economy during recessions by delaying, suspending, or weakening regulations. The argument simultaneously suggests that the costs of regulation might be different depending on the macroeconomic condition of the economy, above all the state of the labor market. A regulation might lead to significant unemployment during a recession, and each lost job might impose significant costs on the laid-off worker; but the same regulation might involve many fewer lost jobs, and much lower cost, during normal or economic boom times. If agencies took account of these macroeconomic effects on a large scale, regulatory policy would be countercyclical.

Congress has also gotten into the act. For example, the Regulation Moratorium and Jobs Preservation Act of 2011 states that ‘No agency may take any significant regulatory action, until the Bureau of Labor Statistics average of monthly unemployment rates for any quarter beginning after the date of enactment of this Act is equal to or less than 7.7 percent.’ The sponsor of the bill, Senator Ron Johnson, hoped to block an EPA regulation of industrial boilers that he believed could risk 338,000 jobs. But the bill allows EPA and other agencies to regulate once unemployment falls, in the spirit of President Obama’s approach to the ozone regulation.

Is there a valid basis for President Obama’s and Senator Johnson’s claims that regulation should be cut back during periods of high unemployment? Critics of regulation have, for quite some time, argued that regulation increases unemployment. In recent work, we have argued that regulators should try to incorporate unemployment costs into their models. We pointed out that studies showed that workers who lost their jobs incurred quite substantial costs, and there was no reason to believe that they were fully compensated ex ante by their wages.

In this paper, we revisit this argument from the macroeconomic perspective taken by Obama and Johnson. Our focus is on the possibility, forcefully suggested by Yair Listokin, that under certain conditions regulation could be used as a tool of macroeconomic policy. A regulation is a kind of tax, and so one would expect regulations, holding all else equal, to suppress economic activity. In principle, the government could stimulate economic activity during recessions by weakening existing regulations—just as one common response to recession is to reduce taxes. It could also suppress economic activity during booms by strengthening regulations or creating new regulations—just as taxes should be raised during upturns. In short, regulation should be countercyclical, just like monetary and fiscal policy.

In our new paper, we discuss how this logic might apply to a variety of regulatory areas, including banking, the environment, workplace safety, immigration, and others. We then explore the legality and practicality of a macroeconomic approach to regulating. Adjusting regulation to reflect the state of economy involves substantial practical hurdles. Regulatory activity is often too slow to respond effectively to temporary downturns. Administrative agencies should consider using automatic triggers and other institutional mechanisms that would allow regulations to adapt more quickly to economic conditions. If the practical hurdles can be overcome, there is a plausible case for using regulatory policy to stimulate the economy, particularly when monetary and fiscal policy are ineffective or unavailable.

Jonathan S. Masur is Professor of Law at the University of Chicago Law School. Eric A. Posner is Professor of Law at the University of Chicago Law School.