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.

Agriculture played a dominant role in the Mexican economy from precolonial times until well into the 20th century. In 1910 two-thirds of the population earned its livelihood from farming or farm work.

Agriculture's importance is perhaps matched only by the relative dearth of quantitative evidence about it. Because virtually all agricultural production took place in family-owned enterprises, there are no corporate financial data on which to draw. In addition, agricultural output was not subject to the excise taxes that were levied on producers in other sectors, so we cannot develop the range of firm-level data sets that we can for other sectors of the Mexican economy. We are, however, able to use U.S. and British trade records to put together data sets on Mexico's importation of capital and intermediate goods for agricultural use. We are also able to use those sources to estimate the net imports and exports of Mexican agricultural products to the United States. This means that we can develop data sets on the flow of new investment and on the economic performance of Mexican staple and export agriculture.

The data sets we have developed, when coupled with the extant secondary literature, allow us to capture the basic outlines of Mexico's agricultural history. Before the revolution, the federal government played an important role in the specification of agricultural property rights. The federal government played a very small role, however, in the enforcement of the property rights system.

This book has addressed the puzzle of how economies can grow amid political violence and disorder. In order to resolve this puzzle, we employed a somewhat heterodox approach, combining methods from history, economics, and political science. We concluded that political instability does not have a systematic impact on economic performance.

The resulting approach to evidence and theory – what some researchers call an analytic narrative – involved three steps: we built a theoretical framework; we gathered systematic quantitative and qualitative data about a polity – Mexico from 1876 to 1929 – that passed from a long period of political stability into a prolonged period of instability; and we used our theoretical framework, coupled to analytic techniques drawn from economics, to analyze the historical evidence in a coherent manner. We specified explicit hypotheses and the counterfactual propositions that emanate from them and then compared the results that one should expect from theory with the results that were obtained in the real world. The result is a book that offers, on the one hand, an analytic economic history of Mexico and, on the other, a generalizable model of the interaction of political institutions and economic performance.

We would venture that the combination of methods and evidence that we have employed is outside the mainstream of research in all three fields on which we have rather shamelessly trespassed. Our trespassing across disciplinary boundaries requires that we say something at this point about the implications of our substantive findings for each of these disciplines.

All governments – stable and unstable – face a commitment problem: if they are strong enough to arbitrate property rights, they are also strong enough to confiscate them. If the population does not believe that the government will refrain from exercising its power, then it will not invest. If there is no investment, there will be little economic activity, and there will be insufficient tax revenues to sustain the government.

The commitment problem is essentially a problem of contract enforcement. In a stable political system, a sovereign government offers property rights protection in exchange for some kind of benefit, typically a stream of tax revenues, from the holders of those property rights. The government and the asset holders assume contractual obligations, much in the same way that any two individuals or corporate bodies can. In a contract between two private parties, of course, the government, typically through the court system, ultimately serves as the third-party enforcer of the contract. A thorny problem arises, however, when the government is itself a party to the contract: the government has a monopoly over the enforcement of property rights but will only enforce those rights when it is in its interest to do so. Even if there is a promise of full enforcement, a sovereign government will be tempted to break it afterward. Private actors can, of course, anticipate government opportunism and therefore choose to invest less or not at all.