Is Now the Time to Regulate?

What to make of the Sarkozy-Merkel insistence that the G-20 focus on tighter regulation of financial institutions? At first blush, it doesn’t make much sense. As Noam Scheiber says, we could have used more risk-averse lending a couple of years ago, but at the moment the problem is that people are too risk-averse so it’s hard to see the urgency of tighter regulations. We’ll need those regulations once recovery is under way, but there’s no need to let them dominate the agenda right now.

I think that makes a lot of sense. At the same time, I can see two arguments on the other side. One is that now is the time to regulate because now is the time that regulation is possible. The very same U.S. and U.K. governments that right now are insisting that regulation can be put off until tomorrow will, when tomorrow comes, return to being totally dominated by the interests of financial executives and not do the regulating. Now is the time when even the big finance countries have the political will to contemplate tougher regulations, so the continentals are right to insist that it be done now lest it not be done at all. The other argument in favor of the Merkel-Sarkozy position appeals to “animal spirits”—ordinary people will feel better about the economic situation and be more willing to make investments in things other than treasuries only if there’s a sense that someone is “cleaning house.” At the moment, the horizon is clouded not only by bad macro news, but by the sense that the world of finance is full of scams and shell games; better regulation could give people more confidence in the system.

So I don’t think the continental position is crazy. What is crazy is continental aversion to economic stimulus. This is sometimes put as Germany needing to do more stimulus. But that’s not quite right. Germany has led the continent in terms of stimulus. What Germany needs to do is trickier; it needs to work together with France on a deal whereby all the continental countries do some stimulus. Small European countries can’t do effective stimulus because they have too much trade. But when you add all the small countries together, they’re a pretty healthy share of the overall world economy. It’s very harmful to have all of them sitting on the sidelines. Ideally, what would come out of this meeting is that the Europeans would abandon their unreasonable stance on stimulus and in exchange the U.S. would adopt Europe’s possibly-reasonable stance on regulation. One fears, of course, that the reverse will happen and we’ll do neither. Meanwhile, for some reason I haven’t been seeing conservative stimulus opponents applauding Europe’s political leaders for advancing the American right’s agenda. It’s curious.