A Theory of the Dynamics of Entangled Political Economy with Application to the Federal Reserve

Abstract

This paper develops the theory of entangled political economy by outlining a process by which the political-economic order can become increasingly entangled. The theory posits that a Big Player polity organization, a key feature of which is a lack of a hard budget constraint, exports this feature to the economy organizations it oversees. The channel through which it does so is the repeated interactions of economy and polity organizations’ agents during times of crisis. The actions of the Federal Reserve, in particular its bailing out of large financial houses in the latter part of the 20th century and the most recent financial crisis, are used as a historical illustration of this theory. The paper also discusses the possibility of constitutional craftsmanship as a solution to the undesirable consequences that accompany increased economy-polity entanglement.

Keywords: bailout, constitutional political economy, entangled political economy, Federal Reserve, financial crisis, residual claimant

JEL Classification: E6, H1, P1