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Whom can we trust to run the Fed? Theoretical support for the founders' views

  • Jon Faust

The Federal Reserve Act erected a unique structure of government decision­making, independent with elaborate rules balancing internal power. Historical evidence suggests that this outcome was a response to public conflict over inflation's redistributive powers. This paper documents and formalizes this argument: in the face of conflict over redistributive inflation, policy by majority can lead to policy that is worse, even for the majority, than obvious alternatives. The bargaining solution of an independent board with properly balanced interests leads to a better outcome. Technically, this paper extends earlier work in making policy preferences fully endogenous and in extending the notion of equilibrium policy to such a world. Substantively, this work provides a simple grounding of policy preferences--largely missing heretofore--linking game theoretic models of policy to historical evidence about the formation of an independent monetary authority.

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File URL: http://www.federalreserve.gov/pubs/ifdp/1992/429/default.htm
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File URL: http://www.federalreserve.gov/pubs/ifdp/1992/429/ifdp429.pdf
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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 429.

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Date of creation: 1992
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Handle: RePEc:fip:fedgif:429
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  1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  2. Loewy, Michael B., 1988. "Equilibrium policy in an overlapping generations economy," Journal of Monetary Economics, Elsevier, vol. 22(3), pages 485-499.
  3. Brendan O'Flaherty, 1990. "The Care And Handling Of Monetary Authorities," Economics and Politics, Wiley Blackwell, vol. 2(1), pages 25-44, 03.
  4. Kenneth Rogoff, 1986. "Reputational Constraints on Monetary Policy," NBER Working Papers 1986, National Bureau of Economic Research, Inc.
  5. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
  6. John Chant & Keith Acheson, 1972. "The choice of monetary instruments and the theory of bureaucracy," Public Choice, Springer, vol. 12(1), pages 13-33, March.
  7. Tabellini, Guido, 1988. "Domestic Politics and the International Coordination of Fiscal Policies," CEPR Discussion Papers 226, C.E.P.R. Discussion Papers.
  8. Sachs, Jeffrey & Alesina, Alberto, 1988. "Political Parties and the Business Cycle in the United States, 1948-1984," Scholarly Articles 4553026, Harvard University Department of Economics.
  9. Blackburn, Keith & Christensen, Michael, 1989. "Monetary Policy and Policy Credibility: Theories and Evidence," Journal of Economic Literature, American Economic Association, vol. 27(1), pages 1-45, March.
  10. Havrilesky, Thomas M, 1987. "A Partisanship Theory of Fiscal and Monetary Regimes," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 308-25, August.
  11. Ariel Rubinstein, 2010. "Perfect Equilibrium in a Bargaining Model," Levine's Working Paper Archive 252, David K. Levine.
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