Money, Financial Intermediation and Governance
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Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.
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Chapter 11: Organizing the Production of Monetary Services

Dino Falaschetti and Michael J. Orlando


And people wondered, if we can explain the laws of the universe, can’t we explain the principles that should control the government? (Anthony Kennedy, US Supreme Court Justice, 2006 address to the ABA assembly, Honolulu, HI) INSTITUTIONS AND COMMITMENT We saw in Part III that ‘time inconsistency’ is problematic in that a policy’s optimality is sensitive to when one evaluates it. The policy that appears best before economic agents play actions can eventually appear sub-optimal as the policy unfolds. This change does not emerge from new information revealing itself over time, or from the preferences of policy makers and constituents diverging, but rather from the manner in which past actions change bargaining positions. As such, time inconsistency is a resistant problem that can leave maximizers able to commit to only suboptimal policies. In this section, we’ll investigate how monetary authorities can govern themselves in a manner that expands this set of commitments. Our model of the monetary authority’s problem (see Chapter 9) highlights a potentially fruitful direction – that is, implement governance features that either increase the cost of acting on inflationary incentives (to choose ␲ = 1) or discourage the maintenance of such an incentive in the first place. To the extent that authorities successfully implement such features, constituents will rationally expect the socially optimal policy (for example, ␲ = 0 in Chapter 9’s model), and monetary authorities will fulfill that expectation. An interesting insight here is that maximizers can do better by increasing the cost of pursuing their incentives, or even...

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