The last two years have seen astonishing changes to how fiscal and monetary authorities in the developed world manage the economy. In the face of the largest global economic contraction since World War II, governments embarked on massive campaigns of economic stimulus, far outpacing the response to the Global Financial Crisis. Central banks similarly engaged in financial intervention on a scale not seen in eighty years. Over roughly a year, the Federal Reserve alone doubled its asset holdings from around $4 trillion to $8 trillion, making for arguably the most aggressive expansion of the United States’ money supply since the Federal Reserve’s founding in 1913. The three largest central banks in the developed world - the Bank of Japan, the European Central Bank, and the Fed now hold almost $25 trillion in assets - more than the total assets of the United States’ commercial banking sector.

In this Review Essay, we explore the idea of “expansionary legal policy” - the use of courts, administration, and regulation to stimulate overall demand for goods and services during recessions. The dramatic financial market events of 2020 and innovations in the practice of fiscal and monetary policy provide a fertile ground for exploring this idea in the context of the regulation of commercial banking. In particular, we argue that perhaps the single legal institution with the greatest ability to use discretion to stimulative effect are banking regulators. The most obvious way to do this is through the exercise of discretion to loosen capital requirements on banks, allowing them to grow in size and activity during recessions. This practice has a checkered history, however. As a result, we sketch an analytical framework for when banking regulators should use their administrative discretion to loosen capital requirements on banks during recessions and thus stimulate the economy. We suggest that both the nature of a crisis (as economic, rather than financial), and the nature of capital forbearance (based on riskless, rather than risk-sensitive assets) are essential preconditions for sound “expansionary banking policy.” We also highlight how developments in macroeconomic management should invite us to rethink basic issues of institutional design in central banking.


Banking and Finance Law | Law and Economics

Date of this Version