Thermostat model of regulation

Many individuals in the media and the blogosphere appear to hold what I call the thermostat model of regulation. Like temperatue, there is a one dimensional scale and one can be too hot - too much regulation, just right (like Goldilocks, a well known expert in financial markets) or too cold (too little regulation). The consensus among amateur economists of the theormostat school is that the financial crisis is the result of the regulatory thermostat being set too low.

It would be difficult to overstate the silliness of this view. What would one think of a doctor who ended each visit with "you should take more drugs" or "you should take fewer drugs" or maybe "you're taking just the right number of drugs"? We would think the doctor was an idiot and a fraud.

So it is with the deep thinkers of thermostatic political economy. Regulation is not a one-dimensional policy lever. Thinking about regulation broadly to include law as well as administrative rules of various sorts, some of it can be quite useful. Other types of regulation impose quite obvious social costs but serve the interests of the small, well-0rganized groups who push for their adoption; the economics literature is full of examples of such laws and regulations. Sadly, this all means that getting the socially optimal regulation in any given context requires actual thought and analysis, about both the design of the institutions that promulgate and enforce regulations as well as about the details of individual regulations.

So, my advice is, if you read something that says we need "more" regulation (or "less" for that matter, as the argument is symmetric) rather than saying that we need "different" or "better" regulation and then providing specific institutional details, you should assume the person in question does not know what he or she is talking about and move on to the next source of information.

One of the largest dangers in the current crisis is that it will spawn a great, squirming brood of bad policies as politicians rush to give the appearance of "doing" something and interest groups take advantage of the crisis atmosphere to push through their particular agendas at the expense of the public good. We saw this after 9/11, which law enforcement agencies at all levels took advantage of to gain legislative changes that weakened civil liberties and increased the potential for abuse of power. We saw it after Enron with the Sarbanes-Oxley Deadweight Loss Creation Act. And we are still suffering from the slew of poorly designed programs bestowed upon us by FDR.