Countercyclical Regulation and Its Challenges

Abstract

Following the 2008 financial crisis, countercyclical regulation emerged as one of the most promising breakthroughs in years to halting destructive cycles of booms and busts. This new approach to systemic risk posits that financial regulation should clamp down during economic expansions and ease during economic slumps in order to make financial firms more resilient and to prick asset bubbles before they burst. If countercyclical regulation is to succeed, however, then policymakers must confront the institutional and legal challenges to that success. This Article examines five major challenges to robust countercyclical regulation – data gaps, early response systems, regulatory inertia, industry capture, and arbitrage – and discusses a variety of techniques to defuse those challenges.