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Daniel Tarullo, Time-Varying Measures in Financial Regulation, 83 Law & Contemp. Probs. 1 (2020).

Abstract: The financial crisis considerably strengthened the case for a “macro-prudential” component in financial regulation – that is, regulatory measures developed and implemented with a view to the stability of the financial system as a whole, rather than with sole attention to the circumstances of individual financial firms. Of particular conceptual appeal are time-varying measures that would discourage the creation of excessive risk, or at least augment the resiliency of firms and markets that could suffer greater losses in periods of economic or financial stress. Unfortunately, the analytic, political and practical hurdles to imposing effective time-varying measures during good times – whether through rules or discretionary action – are substantial. And, during periods of stress, market forces may demand that firms maintain fortress balance sheets, thereby thwarting the macro-prudential aim of allowing those firms to support economic activity through new lending that reduces capital levels and draws down liquidity reserves. This short paper examines these challenges through two examples – counter-cyclical capital requirements and the liquidity coverage ratio. It also suggests an approach that might begin to overcome these challenges, tough only partially and only for macro-prudential measures that increase regulatory requirements. The problem of market constraints on macro-prudential relaxation of requirements remains a problem.