INTRODUCTION

The discussion of the rational foundations of democratic politics includes at least two senses in which democracy can be seen as binding individual agents, and these two senses pick out two aspects of democracy: an institutional aspect and a more human aspect. The institutional aspect focuses on the procedures, rules, and institutions that in one sense constitute democratic politics and which might be seen as binding, constraining, or otherwise structuring the political activity of individuals. The more human aspect focuses on the individuals who live in democratic societies, are bound together into a polity, and must make democracy work. Furthermore, the institutional aspect of democracy highlights one view of economic analysis, by emphasizing the analysis of rational individual responses to democratic institutions and rules, in much the same way as we might analyze individual responses to relative prices. However, the more human aspect of democracy highlights a different economic perspective, by emphasizing the analysis of individuals committing to a common enterprise that offers both intrinsic and instrumental rewards. Very often the former, institutional aspect dominates the economic discussion of democracy to the exclusion of the latter, human aspect – so much so that we often focus on the analysis of narrowly self-interested individuals in democratic settings without asking ourselves whether individuals of that sort have the resources to operate a fully democratic society.

INTRODUCTION

Constitutional rules (or, more generally, constitutional variables) must be analyzed in competitive settings. These rules can constrain the behavior of public sector actors and ensure that political competition remains active and vigorous. Political competition, in turn, can affect the capacity of constitutions to constrain political action. Among the different ways of modeling political competition in the case of democratic societies, we retain two: a) electoral competition, as understood in the probabilistic voting model; and b) competition among centers of power in compound governments (Breton, 1996).

In that framework, the preferences and opinions of citizens in their capacity as voters or demanders of public policies necessarily count. In the literature, these preferences are usually restricted to goods and services; in what follows, they are defined over constitutional variables as well. Moreover, we assume that there will necessarily be trade-offs or compensations between goods and services on the one hand and constitutional variables on the other. This is often the case at the level of individual citizens, but it will obtain at the collective level as a matter of necessity. By itself, this creates a first strong linkage among all issues, including the constitutional ones. In addition, a second linkage derives from the fact that decision-makers in the public sector normally function in institutional settings – parliaments, cabinets, political parties, for instance – that make it natural and easy to bring together apparently unconnected issues.

With the ideal point estimates from Chapter 3, this chapter tests the model's predictions from Chapter 2. For each Fed appointment opportunity, I use the ideal point estimates to order the appointing president and the Senate median among the Fed members who remain after the retiree leaves. This ordering produces a point prediction for the Fed median, which we can compare to the actual Fed median in the data.

The model is used to test two sets of hypotheses for the FOMC and the BOG. The first set of hypotheses answers the question of whether political influence on monetary policy occurs through Fed appointments. The second set concerns the question of influence by whom: the president alone or both the president and Senate. The chapter first considers these hypotheses for the FOMC and then for the BOG.

The results for both the FOMC and the BOG show that political influence occurs. On the FOMC, influence is by both the president and Senate, while on the BOG, it is unclear who influences. But because the FOMC is the more important monetary policy-making body, the results show generally that appointments are an important avenue of political influence on monetary policy by both the president and Senate rather than the president alone.

The chapter proceeds by describing the appointments data. I then restate the model's predictions and enumerate the exact procedures by which I test the predictions. Finally, I present the results in turn for the FOMC and for the BOG.

When Clinton nominated Edward Gramlich and Roger Ferguson to the BOG in the fall of 1997, the Senate reaction was notable for its absence. In stark contrast to the critical attack on Rohatyn, the senators barely commented on these nominations except to praise the nominees' “extraordinary backgrounds” (Senator D'Amato, Chairman of the Senate Banking Committee, quoted in Wessel 1997: A10). The hearings were short, and the full Senate voted quickly to appoint Gramlich and Ferguson.

Clinton had learned a great deal from the Rohatyn nomination. He had discovered that Rohatyn was too far on the easy side relative to what the Senate would tolerate. Perhaps even Rivlin was a bit problematic; the Senate's confirmation vote on her appointment was not unanimous – a rare occurrence. Clinton needed to nominate someone like Meyer, who supported the current Fed policy and thus seemed likely to be a future median member of the FOMC. According to this criterion, Gramlich and Ferguson were good choices. At the time of their confirmation hearings, the FOMC was split into two factions; one side expected an imminent inflation rise while the other side claimed the possibility of a golden age with continued low inflation and high growth. In the hearings, Gramlich and Ferguson both staked a middle position with neither taking sides in the FOMC debate. Satisfied with this anticipated choice by Clinton, the Senate approved both the nominees.

This chapter presents a formal model of the process by which the president and Senate appoint members to the Fed. The model lays out the president and Senate's strategic considerations when they are faced with an appointment opportunity posed by either the retirement or by the expiring term of a Fed member. The president moves first with his power of nomination and thinks about how to exploit that first-mover advantage, while the Senate tries to maximize its veto power over the president's choice of nominee. Once they agree on a nominee, the president and Senate face constraints on how far they can move Fed policy with a single appointment; the Fed's multimember decision-making structure forces the president and Senate to work around the existing Fed members. In sum, the model details how preferences work within the constraints of the appointment process to produce monetary policy.

The model encompasses several of the theories of appointments discussed in Chapter 1. The first is presidential anticipation: in the model presented here, the president always anticipates the Senate's preferences. Under a certain set of circumstances, this means that the president dominates, and at other times, the president compromises with the Senate. Under still other circumstances, neither dominates, and both in a situation of deadlock simply maintain the current policy. Thus given presidential anticipation, the model demonstrates that presidential dominance, presidential compromise, or deadlock can occur.

In the previous chapters, the appointment process is exogenous; I take the process as given and explain how it affects policy. In this chapter, the appointment process is an endogenous object of choice – a dependent variable. I examine the development of the appointment process and claim that it is related to the centralization of the Federal Reserve System. Specifically, I compare and contrast the different appointment structures envisioned in the banking bills from 1903 to 1935.

THE THEORETICAL FRAMEWORK

Assumptions and Definitions

1. The Dependent Variable: Appointment Power. Appointment power is the extent to which the president and Senate can influence policy through appointments. It is related to the appointment structure, the structure of the appointment process and its effects on policy. The appointment structure's components are:

THE NUMBER OF APPOINTED MEMBERS. This variable refers to the number of members appointed by the president and Senate to the Fed's central decision-making board. On the FOMC, by appointing a larger proportion of the central board, the president and Senate have greater control over its decisions, because there is a greater likelihood that the FOMC median is one of their appointees. Because of political uncertainty, the president and Senate will not necessarily advocate a board composed totally of political appointees. With such a board, once in office, opponents can quickly reverse policy gains made by the current president and Senate.

THE LENGTH OF TERMS. This variable refers to how long each central board member serves.

Central banks are often independent, but the degree of independence varies among the banks and over time. Until recently, the British government dictated the Bank of England's monetary policy (Schaling 1995: 91–2). In contrast, the Deutsche Bundesbank controlled policy without government interference (Schaling 1995: 95–6). De Nederlandsche Bank straddled the two extremes; in the event of disagreement, the Dutch finance minister and the central bank had to compromise (Schaling 1995: 93–4). Both the Bundesbank and De Nederlandsche Bank are now parts of the European System of Central Banks, and both should be more similar in their independence; the statute for the new system explicitly prohibits any central bank from taking government instructions (Grilli, Masciandro, and Tabellini 1991; see Cukierman 1992 and Schaling 1995 for excellent reviews of the existing indices of central bank independence).

Although central banks vary in independence, most share a common characteristic: political appointments. Despite the safeguards of central bank independence – for example, no government instructions or closed policy meetings – politicians appoint monetary policy makers. Thus, appointments remain a potential avenue of political influence on monetary policy. The idea behind appointments is simple: if a politician appoints someone like herself, then the appointee should act like the politician when setting monetary policy.

However, influence rarely works so directly or easily. The extent to which politicians influence monetary policy through appointments depends on the appointment process itself, particularly two features of the process. First, different branches of government often share the power to appoint.

Italy's membership in the EMU was unthinkable in early 1996. At that time, Italy fulfilled none of the Maastricht convergence criteria, a number of economic requirements for entry into the EMU. Among European Union (EU) countries, with the exception of Greece, Italy's budget deficit, inflation rate, and interest rates were the highest, and its gross debt was the second highest. In addition, the Italian lira left the Exchange Rate Mechanism (ERM) in 1992.

Within months, the situation changed drastically. In the fall, Italy released its budget forecasts for 1997 and 1998 (Financial Times, September 28, 1996). Surprisingly, the deficit figures nearly achieved the 3 percent convergence criterion level, which raised expectations of Italy's entrance into EMU. Consequently, the Italian inflation and interest rates began to drop, and Italy rejoined the ERM (Financial Times, November 25, 1996). Combined with the fact that the German and French budgets indicated problems with the 3 percent level and that the Belgian gross debt was even higher than the Italian debt, Italy's prospects looked markedly better.

Still, the core EMU countries forcefully raised concerns about Italy's economic fitness for EMU entry. French president Jacques Chirac stated that Italy needed to get its financial house in order and that, “[joining EMU] may take a little bit longer for those who are further behind, like Italy” (Financial Times, October 2, 1996). Hans Tietmeyer, president of the German Bundesbank, proclaimed, “Italy certainly has more to do” (Financial Times, November 29, 1996).

In the previous chapter we explored how, as a theoretical matter, governments and some subgroup of asset holders can create an economic system in which property rights are specified and enforced as private goods. We also explored how the implicit contract between the government and these select asset holders can be made credible via the creation of a coalition with a third group, which receives a stream of rents from the asset holders and provides the government with crucial political support. Finally, we explored why the property rights system laid down by such a coalition might be impervious to changes in the identity and ideology of the government.

Empirical reality is, of course, inevitably messier than any model of it. In order to make models tractable, it is necessary to assume that the actors are behaving as if they are playing a game whose rules and strategies are common knowledge. In the real world, however, it is often the case that some actors have a good sense of the game at hand, while others do not. (Indeed, casual empiricism suggests that many actors in social situations do not even know that there is a game.) Even those who ultimately figure out the rules of the game and the strategies for winning do not start out with that knowledge. They learn the game as they play.