Money, Private Law, and Macroeconomic Disasters

Abstract

In this Article, I use Bernanke's blockbuster as a springboard to make several points that are germane to law and macroeconomics as a field of study. First, understanding acute macroeconomic disasters should be central to this field. It has been said that the Great Depression gave birth to macroeconomics. Law and macroeconomics is likewise the product of a macroeconomic catastrophe: the Great Recession. Sharp contractions in output and employment are a source of incalculable human costs and are politically destabilizing. Better understanding their causes and cures remains as urgent as ever.

Second, Bernanke's paper is a great example of what lawyers and legal scholars can learn from macroeconomists. If the legal and regulatory system is to respond effectively to macroeconomic calamities, it must be attuned to their inner workings. My focus here will be on using the legal and regulatory system to prevent acute macro disasters from happening in the first place rather than on using regulatory levers to apply macroeconomic stimulus once a crisis has already hit. It seems to me that both of these topics belong within law and macroeconomics.

There can be no question that some legal and regulatory frameworks are better than others when it comes to preventing macroeconomic disasters. Gary Gorton has noted that the U.S. financial system and economy enjoyed a long Quiet Period from the early 1930s until 2007.5 This period was not free from financial crises in a generic sense; the bank and thrift debacle of the 1980s led to the failures of over 2,600 U.S. depository institutions holding over $700 billion in combined assets. Bernanke's own famous early-career research on the Great Depression might have led one to expect the 1980s debacle to trigger a severe macroeconomic slump. He had posited that widespread bank failures destroy established information-rich credit relationships that can't be quickly replaced by alternative credit channels, leading to lower overall spending. Yet the bank and thrift debacle of the 1980s was followed by only a mild, garden-variety recession. Why was that crisis so benign, macroeconomically speaking? In my view, legal scholars have remained too agnostic on these matters-though there are exceptions. Different theories about how financial crises produce macro disasters point to very different lines of legal and regulatory analysis. Lawyers can learn a great deal from macroeconomists on these questions. I explore these issues in Part II.

Part III flips the script and asks what macroeconomists can learn from legal experts when it comes to preventing sharp macroeconomic contractions arising from the financial sector.