CENTRAL BANKING AND THE FED: A PUBLIC CHOICE PERSPECTIVE

This paper examines central banking in general and the Federal Reserve system in particular from the perspective of the theory of public choice. It is common to rationalize central banking as being necessary to offset the market failures that would otherwise plague a competitive regime of free banking. By overcoming problems of public goods and externalities, central banking would raise the aggre-gate level of wealth in a society, in much the same manner as the effective governmental provision of security ofproperty and contract would raise it. The theory of public choice, however, explains that the mere devel-opment of a rationalization or justification for a regulation or insti-tution is not the same thing as an explanation of what that regulation or institution actually accomplishes. What is actually accomplished, in economic regulation generally, as well as in banking regulation in particular, depends upon the incentives that characterize a particular institutional or constitutional framework. For instance, the devel-opment of central banking could represent an outcome of a rent-seeking political process. In this case the average level of wealth might be lower than it could be under some alternative institutional regime, but there would be a controlling subset of the population that would be better off under the present regime. This paper first explores possible disparities between the apolo-getics of central banking and its actual accomplishments. It then examines the Federal Reserve system in particular, arguing that the support for central banking seems more likely to be explained by the economic theory of rent-seeking than by the theories ofmarket failure and public goods