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 12: The Case of the ‘Fed’

Dino Falaschetti and Michael J. Orlando


INTRODUCTION Our previous chapters show how an optimal policy can be time inconsistent in the sense that its normative properties change over time. They also argue that delegating authority over relevant policy domains can mitigate this problem. To be sure, delegation does not obviate the time inconsistency problem. Rather, it enhances welfare by increasing the cost for political actors to act on time-inconsistent objectives. In this light, delegation appears to be a good ‘solution’ only to the extent that otherwise opportunistic political principals cannot circumvent the delegation of policy-making authority. The US Federal Reserve System (the ‘Fed’) exhibits several features that increase the cost of circumventing delegation. We’ll examine these features in the present chapter with the objective of better understanding the paradoxical phenomenon that insulating a delegated authority can enhance welfare by diminishing the ‘accountability’ of proximate decision-makers. DELEGATION The Federal Reserve System includes 12 district banks, each of which has a president, and the Federal Reserve Board (FRB).1 District bank presidents receive nominations from their respective boards of directors and confirmations from the FRB to renewable five-year terms. The FRB, on the other hand, consists of seven ‘governors,’ each of whom receives a nomination from the President and confirmation from the Senate to nonrenewable 14-year terms.2 On a rotating basis, four district bank presidents combine with all seven Board members and the New York district president to become the Federal Open Market Committee’s (FOMC) voting membership. The FOMC, in turn, directly determines ‘monetary policy.’3...

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