Fed behavior in periods of price and wage controls

Abstract

There is a literature which addresses the bureaucratic behavior and incentives of the Federal Reserve System. Some of the papers along these lines include Acheson and Chant (1973), Kane (1980), Levy (1981), Toma (1981), Friedman (1982), Shughart and Tollison (1983), and Allen (1986). This paper brings to bear some additional evidence on the behavior and the incentives of the Fed. In particular, we examine the behavior of the Fed during periods of price and wage controls. The public-interest approach to Fed behavior suggests that the Fed should pursue a monetary policy that is consistent with price and wage controls in order to control inflationary forces. The private-interest approach suggests that price and wage controls make seigniorage operations more profitable for the Fed and make it more difficult for Fed overseers to monitor Fed performance, in both cases leading the Fed to pursue monetary expansion in its own self-interest during a period of price and wage controls. The setting of price and wage controls, therefore, provides a test of public- versus private-interest hypotheses about Fed behavior. The paper proceeds as follows. Section 2 develops the competing explanations of Federal Reserve behavior. Section 3 presents the estimates of a structural, money-supply reaction function and an ARIMA/transfer function model of Fed behavior, in each case controlling for ceteris paribus conditions and periods of wage and price controls. The results of both models indicate a falsification of the public-interest explanation of Fed policy. Section 4 offers some concluding remarks.