QE3: An Example of Regulatory Capture
By Randall Holcombe • Monday September 17, 2012 9:02 AM PDT • 3 Comments
One of Nobel Laureate George Stigler’s best-known articles is his “The Theory of Economic Regulation,” in which he argues that over time, regulatory agencies that are designed to regulate industries for the public interest become “captured” by the industries they are supposed to regulate. Stigler’s “capture theory of regulation” concludes that regulators end up regulating industries in a way that benefits the regulated industry, rather than the general public.
The basic logic behind the capture theory of regulation is that while the general public is largely ignorant of the regulator’s activities, those in the regulated industries are well-informed, and pressure regulators for favorable regulation. Furthermore, information about regulated industries is largely under the control of those in the industry, and personal connections between regulators and the regulated also influence regulatory outcomes. The result is that regulatory agencies act as agents for those they regulate, not the general public.
The Federal Reserve Bank’s recent QE3 announcement that they will be buying $40 billion in mortgage-backed securities a month for an indefinite period of time is an excellent example of regulatory capture. Under Chairman Bernanke, the Fed has successfully pushed to increase its regulatory role over the financial industry, and Stigler’s capture theory would predict that the Fed, as a financial regulator, would act to benefit the financial industry it regulates.
In recent posts on The Beacon I have argued that the Fed’s purchases of these securities is unprecedented, that it is an example of crony capitalism, and now am arguing that it is an example of the regulatory capture that Stigler described. Just like the government’s purchase of Chevy Volts, the Fed is creating demand for a product (morgtage-backed securities) that is in weak demand, for the benefit of the industry it regulates.
QE3 offers lots of lessons to students of economic policy, but none of them put the Fed in a particularly good light. Bernanke’s policies create a serious threat to the Fed’s independence. Prior to 2008 one could see the Fed as an impartial administrator of monetary policy. Under Bernanke it has expanded its regulatory powers, is heavily involved in economic policy, and has been captured by the industry it is supposed to be regulating. Bernanke’s actions offer good arguments to those who would like to see the Fed’s independence reduced.
Tags: Corporatism, Economics, Federal Reserve, Government subsidies, Integrity, Money and Banking, Politics, Regulation, Transparency 
QE3 is about growing the monetary base in order to grow NGDP. It doesn’t matter what the Fed buys.
chris mahoney | Sep 17, 2012 | Reply
“Under Bernanke it has expanded...in economic policy.”
Do you mean fiscal policy? I ask because economic policy is something the Fed has always had a voice in through monetary policy.
Nathan | Sep 18, 2012 | Reply
Thanks for the comments, Chris and Nathan.
Chris, I have to disagree with your last sentence. Even if the sole motivation of QE3 is to increase the monetary base, it does matter what the Fed buys. By buying mortgage-backed securities it is increasing the demand for them and supporting their price, to the benefit of the financial industry. My earlier post comparing the Fed’s buying mortgage-backed securities with the Defense Department’s buying Chevy Volts makes this point better (and I didn’t want to repeat too much from my earlier post when making this one). The Fed’s pre-2008 policy of only buying government securities was more neutral toward various sectors and individual businesses.
Nathan, you are right that the Fed has “always” used monetary policy, although more actively since the 1950s than before. Of course, that’s more than half a century. The economic policy I’m talking about is the Fed’s targeting benefits to specific firms and industries, most notably, the financial firms that the Fed regulates. Prior to 2008 the Fed did not do this. Its first big foray in this way was its bailout of AIG, and its recent actions show that the AIG bailout was not a one-time event, but a change in the Fed’s mode of operation.
Randall Holcombe | Sep 18, 2012 | Reply