Did Reserve Banks Really Compete?

Economists have tidy stories about why regulation arises and how it subsequently evolves. According to a technocratic story line, regulatory bodies are borne in the aftermath of crisis, with a clear-cut intent of remedying some defect in the organization of the regulated industry. The regulatory body collects information from all interested parties and then issues a mandate that satisfies the economist’s criteria of efficiency. A more cynical story line, while tending to agree with the why of regulation’s birth, takes issue with the how of its subsequent evolution. After birth, the law of unintended consequences comes into play, with the original motivation morphing into an attempt by the regulated firms, or some other special interest group, to capture the regulatory body. The attempt proves successful, since the interested group stands to gain or lose the most from the regulatory agency’s mandates and hence will be the ones most energized to influence the regulatory process. In the long run, the original regulatory intent is lost from collective memory. The implicit assumption, underlying both the technocratic and special interest stories, is that regulation is successful in thwarting the competitive urges of individual firms in the industry.