Integrating Micro and Macro Policy Levers in Response to Financial Crises

Abstract

The 2008–09 Global Financial Crisis originated from a poor incentive structure in the asset market derived from subprime mortgages. The ultimate bursting and unwinding of an asset bubble (here highly overvalued real estate prices woven into a complex multilayer network of securitization, so called collateralized debt obligations or CDOs) put enormous stress on the financial system, spreading through the global network economy and ultimately resulting in the worst economic crisis since the Great Depression. Economists today agree that the severe economic fallout can be largely attributed to the poor systemic performance of international financial markets. Global macroeconomic imbalances, as well as market failures such as excessive risk taking, misaligned incentives of rating agencies, inefficient liquidity provisions within banks and systemic risk or contagion, i.e., the international and inter-sectoral public goods nature of financial stability, were not sufficiently accounted for by regulation and international macroeconomic policy. This combined financial and economic crisis environment not only put the intrinsic connection between the financial and the real economy back into the spotlight, but also opened up a policy debate about how to ensure macroeconomic and financial stability without jeopardizing microeconomic foundations of the real economy such as competition. In sum, the resulting policy challenge is twofold: First, a new and sustainable balance between free markets, macro industrial policies, and governmental regulation needs to be found in the financial sector, and second, strategic interactions between macro and microeconomic policy goals need to be identified, understood, and balanced. This article will focus on the interaction between macroeconomic crisis management and prudential regulatory responses on the one hand, and competition policy and market structure on the other. We provide a simple economic framework for thinking about the relationship between macro and micro policies as a function of the immediate policy environment, i.e., “extraordinary” financial instability and imminent economic crisis versus “ordinary,” stable economic circumstances. Specifically, we claim that— during severe financial crises—the overall success of policy responses depends on the coordination of three related decisional vectors. First, policy makers must coordinate the responses of multiple regulatory and political actors. Second, they need to follow a systematic, rather than ad hoc, approach that diminishes moral hazard and leaves open a reasonable exit strategy. Finally, policy makers need to consider time consistency. In other words, they need to avoid the temptation to excessively discount post-crisis effects. Overall, this work shall add structure to the ongoing policy debate and provide conceptual guidance for lawyers and economists trying to address the challenges of micro and macro policy integration. In Part I, we provide an overview of the relationship between the financial and real economic sectors and between systemic financial stability and micro-competitive effects. In Part II, we advance our core theoretical proposition—the strategic complementarity of macro and micro policy levers during financial crises. In particular, we demonstrate that policy responses that fail to consider and balance the three key dimensions—coordination among decision-makers, a systematic approach, and time consistency—run the risk of harming both macro and micro-economic well-being in the long run. Finally, in Part III, we illustrate the quite different responses to the financial crisis of the European Union and the United States along the three key dimensions. Our goal is not to provide a comparative assessment of the two systems’ responses or a trans-Atlantic scorecard, but rather to illustrate the possibilities and challenges of coordinating macro and micro responses along the three key dimensions.