In our ongoing exploration of price theory challenges, we delve into an intriguing discussion led by Professor Bryan Cutsinger. This installment invites you to share your insights in the comments section, where Professor Cutsinger will engage for the next few weeks. To view all of his problems and solutions, consider subscribing to his EconLog RSS feed. May your analyses be sharp and informed, as we celebrate the principles of price theory!
Question: The U.S. Federal Reserve stands apart from most governmental organizations in two significant ways:
- The Federal Reserve sets its own operating budget and sends any surplus revenue to the U.S. Treasury.
- The Federal Reserve has some influence over its revenue, deriving income from issuing currency and managing interest-bearing assets. Securing more revenue by producing more money than what is compatible with price stability can boost this income in the short term.
Contrary to a private entity, the Federal Reserve’s residual income is not owned by any individual or group.
(a) Discuss how the lack of a residual claimant impacts the Federal Reserve’s incentives when it comes to determining the size of its operating budget. In your analysis, consider whether this structure fosters the most cost-effective production methods.
(b) Outline how the Federal Reserve’s capacity to generate income through the creation of money could lead to an inflationary tendency, even if maintaining price stability is a declared policy goal.
(c) Examine why transferring excess revenue to the Treasury may not completely resolve these incentive issues. Use fundamental economic principles to support your explanation.
Engaging with these questions provides invaluable insight into the unique operational dynamics of the Federal Reserve. Understanding these nuances is crucial for anyone interested in the intersection of economics and public policy.
