Mark Toma

The demise of the public-interest model of the Federal Reserve System: A review essay

The Political Economy of American Monetary Policy (Cambridge University Press, Cambridge, 19901, edited by Thomas Mayer, is a collection of one previously published and eighteen unpublished works that seeks to review, consolidate, and extend the growing literature on a positive theory of the Federal Reserve System. A major theme of the collection is that the traditional public interest view of the Fed has little to offer as a guide to understanding the behavior of Federal Reserve officials. At the same time, the collection offers a word of caution to practitioners of the positive theory who use a ‘naive’ public-choice approach. According to this subplot, a narrow self-interest approach to the Fed is not much better than the traditional alternative. A general theory of the Federal Reserve System requires the right blend of the best elements from the staid public-interest view and the renegade public-choice view. As a review of the current state of the literature this collection of works has much to offer. The book is at its best in posing questions that force not only the public-interest proponent but also the naive public-choice theorist to rethink their positions. The book is less useful, I think, as a road map to future research. In contrast to this book’s premise, the problem I see with the naive public-choice approach is not that it has been too radical, but that it has not been radical enough. The renegade assumption that Fed decisionmakers are self-interested utility maximizers is misleading only when used within the context of a misspecified model of the macroeconomy. I argue in this review essay that the next discrete step in the evolution of a positive theory of central banking is to supplement the self-interest assumption with

The role of tax bases and collections costs in the determination of income tax rates, seigniorage and inflation

A growing theoretical literature on optimal taxation predicts that governments will set the tax rates on money holdings and on more traditional tax bases to minimize the deadweight losses of collecting government revenue. Under the presumption that relative collection costs and tax bases have not changed significantly over time, the empirical time-series seigniorage literature has focused on the theorys tax smoothing implication, finding only weak support. We show that changes in collections costs and tax bases played an important role in the determination of tax composition and find stronger support for tax smoothing when this is taken into account.

A Positive Model of Reserve Requirements and Interest on Reserves: A Clearinghouse Interpretation of the Federal Reserve System

This paper develops a positive model of reserve requirements and interest on reserves, based on the observation that Congress exempted the Fed from a legal restriction that had prevented private clearinghouses from issuing their own currency. Eliminating the restriction provided the Fed with a source of revenue that could be used to finance general government outlays and to pay implicit interest on reserves. The model implies that the government’s financing requirements help explain reserve requirement movements and that interest rates on reserves vary with market loan rates. Cointegration, error-correction, and Granger-causality tests provide supporting evidence.

Interest Rate Controls: The United States in the 1940s

In 1942 the U.S. Treasury and the Federal Reserve agreed to keep the interest rate on long-term government bonds below a ceiling of 2.5 percent. Assuming rational expectations, the ceiling on long-term interest rates can be viewed as a government commitment to low long-run inflation. The Fed also agreed to buy and sell short-term government bonds at a below-market rate of 3/8 percent. This policy did not result in long-run inflation because it was narrowly confined to 3-month Treasury bills.

Inflation, reserve requirements, and real interest rates with direct and indirect loan markets

Abstract The paper constructs an overlapping generations model with a banking sector but allows for both direct lending and indirect lending through banks. In this model we reexamine the long-run effects of a change in the inflation rate. An increase in the inflation rate raises the tax on banks, since they are required to hold reserves, and causes banks to lower deposit rates. This induces tow effects. First, some depositors switch from bank deposits to direct lending. This tends to lower loan rates of interest as direct lenders do not have to hold reserves. Second, some depositors will increase current consumption, and this tends to raise the loan rate. For reasonable values of the parameters the second effect may dominate even if the interest elasticity of consumption is very small.

World War II, interest rates, and fiscal policy commitments

Abstract During a war, government will be able to issue debt only if the public expects that the value of the debt will not be inflated away after the war. I argue that the United States government used the 1940s bond price support program to convey its intention to offset high rates of money production during the war with low rates later. Whether this program was credible depended on the expected duration of the war and the rule the public expected government to use in tax-financing the postwar government expenditures. Ex ante, the public may have been rational in buying low rate long-term war bonds, even though postwar money rates generated negative realized rates of return.