The demise of the public-interest model of the Federal Reserve System: A review essay

Abstract

The Political Economy of American Monetary Policy (Cambridge University Press, Cambridge, 19901, edited by Thomas Mayer, is a collection of one previously published and eighteen unpublished works that seeks to review, consolidate, and extend the growing literature on a positive theory of the Federal Reserve System. A major theme of the collection is that the traditional public interest view of the Fed has little to offer as a guide to understanding the behavior of Federal Reserve officials. At the same time, the collection offers a word of caution to practitioners of the positive theory who use a ‘naive’ public-choice approach. According to this subplot, a narrow self-interest approach to the Fed is not much better than the traditional alternative. A general theory of the Federal Reserve System requires the right blend of the best elements from the staid public-interest view and the renegade public-choice view. As a review of the current state of the literature this collection of works has much to offer. The book is at its best in posing questions that force not only the public-interest proponent but also the naive public-choice theorist to rethink their positions. The book is less useful, I think, as a road map to future research. In contrast to this book’s premise, the problem I see with the naive public-choice approach is not that it has been too radical, but that it has not been radical enough. The renegade assumption that Fed decisionmakers are self-interested utility maximizers is misleading only when used within the context of a misspecified model of the macroeconomy. I argue in this review essay that the next discrete step in the evolution of a positive theory of central banking is to supplement the self-interest assumption with