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The Political Economy of Central Banking in the United States or Quis Custodiet Ipsos Custodes

The fact that monetary policy can be strongly influenced by political considerations has long been recognized. The topic has increased in importance with the rise of monetarism. Theories that attach great importance to money supply require some explanation of changes in money supply. Gold flows and institutional changes provide easy explanations for some noteworthy historical episodes but they cannot explain the behavior of those central banks that can control the money supply. Hence the emphasis on politics. The movements of money supply can be explained in terms of political events and provide an exogenous driving force for the system. A whole literature on electoral cycles has begun to develop. In this paper I shall argue that central bank policy in the United States is indeed influenced by political considerations. In Section I, I have sketched out the ways in which the Federal Reserve System is exposed to political forces. I have also indicated some of the intellectual, ideological and economic interest forces which work through those channels. In Section II, I have argued that postwar Federal Reserve policy has to be interpreted in terms of modes of operation developed to conserve the System’s power to influence events when it is important to do so. Much of the System’s behavior can be understood as defense against attacks by populists and monetarists. In my view, simple election buying has played a minor role. In Section III, I review some recent proposals for the use of new monetary aggregates. I argue that those proposals make more political than economic sense.