Current debates over international coordination of macroeconomic policy pose interesting conundrums for our understanding of domestic monetary policy. For a number of years the United States has been exerting pressure on Japan and West Germany to pursue an easier monetary policy, and particularly in the case of the West Germans the United States has been unsuccessful. German officials cite fear of inflation as their rationale for a restrictive policy. Yet, last year, consumer prices fell in West Germany, casting suspicion on either the sincerity or wisdom of the German government's stance.

An alternative explanation, now recognized by economists and other observers, is that macroeconomic expansion is thought by the German government to be incompatible with maintenance of corporate profitability in West Germany (Llewellyn 1983). The German case suggests the need to rethink traditional approaches to understanding macroeconomic policy in general and monetary policy in particular.

This chapter attempts such a rethinking. Using the case of the United States, we investigate the hypothesis that the Federal Reserve's monetary policy is motivated by a concern for corporate profitability. We reinterpret the standard evidence on the determinants of monetary policy in light of this hypothesis. The results are consistent with the view that the Federal Reserve is acting so as to maximize the (weighted) profitability of finanical and nonfinancial corporations. Furthermore, there is no evidence that the Fed independently attempts to promote labor's interests.

Theories of monetary policy

It is well established that the Federal Reserve responds to inflation and the growth of output by leaning against the wind. Reaction-function studies such as that of McNees (1986) support this proposition.