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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page Whom can we Trust to Run the FED? Theoretical Support for the Founders' Views
Jon Faust
1992-429  (April 1992)

Abstract:  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.

Full paper(404 KB PDF)

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