What or who governs central bank decisions? Most considerations focus on motivations. Instead, we consider the extent to which specific behaviors have adaptive value in the context of central banking. From that perspective, poor decisions are not the product of poor motivations. They are, instead, a product of the poor institutions within which central bank decision makers operate.
This is a preview of subscription content, log in to check access.
Buy single article
Instant access to the full article PDF.
Price includes VAT for USA
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
This is the net price. Taxes to be calculated in checkout.
We employ the terms ‘selection’ and ‘adaptation’ throughout. By selection, we mean the filtering process of institutions. By adaptation, we mean the durable properties of entities that remain after the filtering process has weeded out entities lacking those properties. Hence, a durable property is said to have ‘adaptive value’ if it is selected for in the filtering process.
Although Alchian (1950, p. 212) articulates his view in the context of profit maximization by firms, he maintains that it applies equally to utility maximization by consumers.
One might reasonably argue that the rationality postulate only has empirical content in the context of an agent’s perceived problem-environment. See Vanberg (2004).
The rotation is such that one president from Boston, Philadelphia, or Richmond; Cleveland or Chicago; Atlanta, St. Louis, or Dallas; and Minneapolis, Kansas City, or San Francisco always sit on the open market committee. Although none can vote, the seven out-of-rotation regional Reserve Bank presidents attend and participate in discussions at FOMC meetings.
Although Reserve Bank presidents are not bound by term limits, they are subject to mandatory retirement at age 65. If permitted by the Bank’s board, a president appointed after turning 55 can serve for 10 years or aging out at 70, whichever occurs first.
The effect is perhaps even stronger for positions of Chair and Vice Chair, insofar as they play more important roles in setting the agenda or building consensus. Along those lines, Kane (1988) models the president’s decision to appoint the Chair as a financial portfolio investment.
This is perhaps less important in recent years, when monetary policy has been conducted by varying the interest on excess reserves and the rate paid on reverse repurchase agreements. Both of these rates are determined exclusively by members of the Board of Governors. Jordan and Luther (2018) argue that the Fed’s new operating regime reduces its independence.
Our approach would seem to suggest that, if the President has the right ideas about maximizing social welfare, he will select central bankers with the right ideas about maximizing social welfare and the social-welfare-maximizing monetary policy will be adopted. However, it is important to remember that the President also is a product of selection mechanisms—and it is not obvious why one should assume that a candidate with the right ideas about maximizing social welfare will be selected as President. Indeed, a large literature following (Riker 1962) suggests that a President who concentrates benefits and disperses costs is more likely to prevail.
We do not mean to imply that the appointment process is the only mechanism at play. For example, Shughart and Tollison (1983) consider the tradeoff Fed officials face between padding their budgets and purchasing autonomy from the Treasury by remitting more seigniorage. Grier (1991, 1996) finds that monetary policy is affected by the political views of the leadership on congressional oversight committees. Hess and Shelton (2016) find that, at least prior to 1982, the Fed adjusted monetary policy in response to bills credibly threatening its power. See also Kvasnicka (2005).
We follow Wagner (1977) in focusing on seigniorage rather than more traditional accounts of a political business cycle, since the former allows incumbents to concentrate benefits through targeted spending efforts in swing districts as opposed to a broad-based reduction in unemployment or increase in output.
Colussi (2018) finds that around 43% of articles published in top general-interest economics journals are authored by scholars with an observable social tie to an editor of the journal at the time of publication.
Much the same could be said about the academic hiring process, wherein committee members are more likely to recommend and departments are more likely to extend offers to those candidates who correspond more closely to the prevailing conception of scientific merit.
For example, Posner (2017) argues that, while the Fed acted without legal authority, its response was needed to resolve the crisis.
Humphrey (1989) provides a more complete summary of Bagehot’s rules.
Much disagreement exists, to be sure. For example, Kaufman (1991) argues that central banks should supply general liquidity through open market operations rather than specific liquidity to individual financial institutions. Nonetheless, Bagehot’s classic lender-of-last-resort doctrine functions as a widely accepted baseline, from which departures might be considered.
There probably never has been a tighter congruence between the actions of a Fed chair and his academic work. In a series of influential papers, Bernanke (1981, 1983) argued that the severity of the Great Depression could not be accounted for by the initial collapse in liquidity alone; that the failure of banks resulted in a breakdown of financial intermediation, further straining the system. Bernanke’s public remarks (Bernanke 2008, 2009a, b) make clear that he feared a similar breakdown in the early days of the crisis; that the Fed’s unprecedented actions were intended to fight contagion.
In recent years, for example, the Fed has acted as if its 2% inflation target were a ceiling. Fed officials seem unwilling to risk 1970s-level inflation rates, despite the potential benefits of returning to the price level’s original trend.
Alchian, A. A. (1950). Uncertainty, evolution, and economic theory. Journal of Political Economy, 58(3), 211–221.
Anderson, G. M., Shughart, W. F., & Tollison, R. D. (1988). A public choice theory of the great contraction. Public Choice, 59(1), 3–23.
Auerbach, R. D. (1985). Politics and the federal reserve. Contemporary Economic Policy, 3(5), 43–58.
Bailey, M. J. (1956). The welfare cost of inflationary finance. Journal of Political Economy, 64(2), 93–110.
Becker, G. S. (1962). Irrational behavior and economic theory. Journal of Political Economy, 70(1), 1–13.
Becker, G. S. (1963). Rational action and economic theory: A reply to I. Kirzner. Journal of Political Economy, 71(1), 82–83.
Belongia, M. T. (2007). Opaque rather than transparent: Why the public cannot monitor monetary policy. Public Choice, 133(3), 259–267.
Bernanke, B. S. (1981). Bankruptcy, liquidity, and recession. American Economic Review, 71(2), 155–159.
Bernanke, B. S. (1983). Nonmonetary effects of the financial crisis in the propagation of the Great Depression. American Economic Review, 73(3), 257–276.
Bernanke, B. S. (2008). Federal reserve policies in the financial crisis. In Board of governors of the federal reserve system, Speech greater Austin chamber of commerce, Austin, TX. December 1.
Bernanke, B. S. (2009a). Reflections on a year of crisis. In Board of governors of the federal reserve system, speech federal reserve bank of Kansas City’s annual economic symposium, Jackson Hole, WY, August 21.
Bernanke, B. S. (2009b). Regulatory reform. In Board of governors of the federal reserve system, Testimony. Committee on Financial Services, U.S. House of Representatives, Washington, D.C., October 1.
Bernanke, B. S. (2012). The federal reserve’s response to the financial crisis, In Board of governors of the federal reserve system, Lecture 3. Lecture. George Washington University School of Business, Washington, D.C., March 27.
Bernanke, B. S. (2013). Opening remarks by Chairman Ben S. Bernanke at the ceremony commemorating the centennial of the Federal Reserve Act. In Board of governors of the federal reserve system, December 16.
Bernanke, B. S. (2015). The courage to act: A memoir of a crisis and its aftermath. New York: WW Norton & Company.
Blau, B. M. (2017). Lobbying, political connections and emergency lending by the federal reserve. Public Choice, 172(3–4), 333–358.
Blau, B. M., Brough, T. J., & Thomas, D. W. (2013). Corporate lobbying, political connections, and the bailout of banks. Journal of Banking and Finance, 37(8), 3007–3017.
Buchanan, J. M. (1987). The constitution of economic policy. American Economic Review, 77(3), 243–250.
Burns, S. A., & White, L. H. (2017). Monetary policy without romance: The political economy of the modern Fed. In Working paper.
Chappell, H. W, Jr., Havrilesky, T. M., & McGregor, R. R. (1993). Partisan monetary policies: Presidential influence through the power of appointment. Quarterly Journal of Economics, 108(1), 185–218.
Colussi, T. (2018). Social ties in academia: A friend is a treasure. Review of Economics and Statistics, 100(1), 45–50.
Friedman, M. (1953). The methodology of positive economics. In Essays in positive economics. Chicago: University of Chicago Press, 3–43.
Friedman, M. (1969). The optimum quantity of money. The optimum quantity of money and other essays. Chicago: Aldine.
Friedman, M. (1982). Monetary policy: Theory and practice. Journal of Money, Credit and Banking, 14(1), 98.
Grier, K. B. (1991). Congressional influence on U.S. monetary policy: An empirical test. Journal of Monetary Economics, 28(2), 201–220.
Grier, K. B. (1996). Congressional oversight committee influence on US monetary policy revisited. Journal of Monetary Economics, 38(3), 571–579.
Havrilesky, T. (1994). The political economy of monetary policy. European Journal of Political Economy, 10(1), 111–134.
Heckman, J. J., & Moktan, S. (2018). Publishing and promotion in economics: The tyranny of the top five. In NBER Working Paper No. w25093.
Hess, G. D., & Shelton, C. A. (2016). Congress and the federal reserve. Journal of Money, Credit and Banking, 48(4), 603–633.
Hogan, T. L., Le, L., & Salter, A. W. (2015). Ben Bernanke and Bagehot’s rules. Journal of Money, Credit and Banking, 47(2–3), 333–348.
Hogan, T. L. (2015). Has the fed improved US economic performance? Journal of Macroeconomics, 43, 257–266.
Humphrey, T. M. (1989). Lender of last resort: The concept in history. Economic Review, 75(2), 8–16.
Jordan, J., & Luther, W. J. (2018). Central bank independence and the Federal Reserve’s New Operating Regime. Working paper.
Kane, E. J. (1980). Politics and fed policymaking: The more things change the more they remain the same. Journal of Monetary Economics, 6(2), 199–211.
Kane, E. J. (1988). The impact of a new federal reserve chairman. Contemporary Economic Policy, 6(1), 89–97.
Kaufman, G. G. (1991). Lender of last resort: A contemporary perspective. Journal of Financial Services Research, 5(2), 95–110.
Kirzner, I. M. (1962). Rational action and economic theory. Journal of Political Economy, 70(4), 380–385.
Kirzner, I. M. (1963). Rational action and economic theory: Rejoinder. Journal of Political Economy, 71(1), 84–85.
Kvasnicka, M. (2005). Independence and responsibility of central banks. New Perspectives on Political Economy, 1(2), 50–75.
Lipsey, R. G., & Lancaster, K. (1956). The general theory of second best. Review of Economic Studies, 24(1), 11–32.
Mankiw, N. G. (1987). The optimal collection of seigniorage: Theory and evidence. Journal of Monetary Economics, 20(2), 327–341.
Mayer, T. (2000). Using government documents to assess the influence of academic research on macroeconomic policy. In R. E. Backhouse & A. Salanti (Eds.), Macroeconomics and the real world (Vol. 2, pp. 233–250)., Keynesian economics, unemployment, and policy Oxford: Oxford University Press.
McCallum, B. T. (1999). Recent developments in monetary policy analysis: The roles of theory and evidence. Journal of Economic Methodology, 6, 171–98.
Meltzer, A. H. (2011). Politics at the fed. Journal of Monetary Economics, 58(1), 39–48.
Niskanen, W. A. (1968). Nonmarket decision making: The peculiar economics of bureaucracy. American Economic Review, 58(2), 293–305.
Polanyi, M. (1963). The republic of science: Its political and economic theory. Minerva, 1, 54–74.
Posner, E. A. (2017). What legal authority does the fed need during a financial crisis. Minnesota Law Review, 101(4), 1529–1578.
Puckett, R. H. (1984). Federal open market committee structure and decisions. Journal of Monetary Economics, 14(1), 97–104.
Ramirez, C. D. (2011). The 700 billion bailout: A public-choice interpretation. Review of Law and Economics, 7(1), 291–318.
Riker, W. H. (1962). The theory of political coalitions. New Haven: Yale University Press.
Rotemberg, J. J. (2013). Shifts in US federal reserve goals and tactics for monetary policy: A role for penitence? Journal of Economic Perspectives, 27(4), 65–86.
Salter, A. W. (2016). Robust political economy and the lender of last resort. Journal of Financial Services Research, 50(1), 1–27.
Sanchez, D. (2012). The optimum quantity of money. Business Review, Q4, 8–15.
Selgin, G. (2012). L-street: Bagehotian prescriptions for a 21st century money market. Cato Journal, 32(2), 303–332.
Selgin, G., Lastrapes, W. D., & White, L. H. (2012). Has the fed been a failure? Journal of Macroeconomics, 34(3), 569–596.
Shughart, W. F., & Tollison, R. (1983). Preliminary evidence on the use of inputs by the federal reserve system. American Economic Review, 73(3), 291–304.
Shughart, W. F. (2011). The new deal and modern memory. Southern Economic Journal, 77(3), 515–542.
Smith, A. (1904 ). In Edward, C. (ed.) An inquiry into the nature and causes of the wealth of nations. Indianapolis: Liberty Fund.
Toma, E. F., & Toma, M. (1985). Research activities and budget allocations among federal reserve banks. Public Choice, 45(2), 175–191.
Toma, M. (1982). Inflationary bias of the Federal reserve system: A bureaucratic perspective. Journal of Monetary Economics, 10(2), 163–190.
Vanberg, V. (2004). The rationality postulate in economics: Its ambiguity, its deficiency and its evolutionary alternative. Journal of Economic Methodology, 11(1), 1–29.
Wagner, R. E. (1977). Economic manipulation for political profit: Macroeconomic consequences and constitutional implications. Kyklos, 30(3), 395–410.
White, L. H. (2005). The federal reserve system’s influence on research in monetary economics. Econ Journal Watch, 2(2), 325–354.
We thank David Andolfatto, Gerald P. Dwyer, Jerry Jordan, Peter Leeson, Gerald P. O’Driscoll Jr., William F. Shughart II, and Lawrence H. White for providing valuable comments on an earlier draft of this work.
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations
About this article
Cite this article
Salter, A.W., Luther, W.J. Adaptation and central banking. Public Choice 180, 243–256 (2019). https://doi.org/10.1007/s11127-018-00633-9
- Central bank