A Theoretical Framework for Law and Macroeconomics

Abstract

This Article considers the effects of law within a Keynesian macroeconomic model on the economy. Using the IS/LM model at the heart of “short-run” macroeconomics, I argue that law affects spending (“aggregate demand”) and that the changes in spending induced by law can affect output. I contrast the law and macroeconomic perspective with the law and microeconomic approach that has dominated law and economics. I demonstrate that law’s effects on aggregate demand become particularly important when monetary policy is constrained by the “zero lower bound” on nominal interest rates. At the zero lower bound, interest rates cannot adjust to bring aggregate demand into balance with the economy’s supply potential. Economic output falls short of its potential due to inadequate demand. At the zero lower bound, I argue that some micro-economically disfavored legal instruments, such as command and control regulation crafted to increase spending, become appealing relative to seemingly superior alternative instruments such as Pigovian taxation.