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In Praise of (Some) Red Tape: A New Approach to Regulation

Authors


  • This paper is an extension of a Centre for International Finance and Regulation (CIFR) commissioned piece, Removing ‘Red Tape’ Regulation in an Uncertain Environment, requested by the 2014 Australian Financial System Inquiry (FSI or ‘Murray Inquiry’) and prepared with their permission. We wish to acknowledge the facilitation of David Gallagher (CEO of the CIFR) in both initiating this work and liaising with the FSI over its scope. We also wish to acknowledge feedback from various officers at the FSI, APRA and the RBA – in particular, Malcolm Edey, Luci Ellis, John Laker and Melisande Waterford. The discussion of regulatory independence in this paper is the work of Gordon Menzies and the CGE simulations are the work of Peter Dixon and Maureen Rimmer. Menzies wishes to thank Mardi Dungey and Graeme Wells for the invitation to the regulation panel at the 2014 Hobart conference of economists, which motivated the creation of the analytic framework. The paper was runner-up for the 2015 CIFR research pitch day competition initiated by Robert Faff, and Menzies is grateful for the research impetus of his research template (Faff, 2015). Finally, he wishes to thank Jean-Charles Rochet and Charles Calomiris for helpful discussions. The authors are very grateful for all this wide-ranging feedback, but any remaining errors are our own.

Abstract

The costs of removing red tape include a lower chance of detecting recession-generating flaws in the financial system. What we call independent dimensions of regulation (IDRs) operate more or less independently from other groupings. If an IDR's optimality is unknown, it may be risky to remove. Uncertainty thus implies that (some) red tape – a small amount of overregulation – is justified, in contrast to the Brainard principle that uncertainty dictates less policy activism. The long-run Gross Domestic Product (GDP) benefit of a 1 per cent improvement in financial services productivity is 0.06 per cent in our computable general equilibrium model. These relatively modest gains reinforce our conclusion.

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