Better Rules for Worse Economies: Efficient Legal Rules Over the Business Cycle

Abstract

Laws and regulations designed for robust economies often perform miserably in deep recessions. In a healthy economy, the best legal rule from an economic perspective maximizes productive capacity. In a recession, however, spending, not productive capacity, limits the size of the economy. Recessions also shift incentives, meaning that inputs to an efficient legal rule change with the business cycle for microeconomic as well as macroeconomic reasons. As a result, legal rules that are efficient in a growing economy often waste resources in recessions. Unemployment insurance (" UT") eligibility rules illustrate the business cycle variability of the efficient legal rule. In robust economies, tight unemployment eligibility rules maximize capacity by encouraging greater labor supply and consequently higher output. In recessions, by contrast, labor supply does not, constrain output. Boosting incentives to find work does not increase employment when jobs, rather than workers, are scarce. Instead, spending (" aggregate demand") is the economy's limiting factor. In recessions, lax unemployment eligibility rules reduce inequality and enhance spending and demand for labor, resulting in higher output. Previous writing in law and macroeconomics prescribes a" countercyclical legal policy" response to variability in the efficient legal rule over the business cycle.'If strict legal rules raise output in ordinary times but permissive rules raise output in recessions, then legal rules should be tight in the growth phase of the business cycle but lax in recessions.'And UT policy sometimes strives for this countercyclical variation. In the CARES Act passed in March 2020 to mitigate COVIID-19's devastating impacts on the economy,