The nature and scope of the Federal Reserve's authority and the structure of its decision making are now “on the table” to an extent that has not been seen since 1935, and the Fed's vaunted independence is under some attack. This essay asks what the Federal Reserve should—and shouldn't—do, leaning heavily on the concept of economies of scope. In particular, I conclude that the central bank should monitor and regulate systemic risk because preserving financial stability is (a) closely aligned with the standard objectives of monetary policy and (b) likely to require lender of last resort powers. I also conclude that the Fed should supervise large financial institutions because that function is so closely to regulating systemic risk. However, several other functions now performed by the Fed could easily be done elsewhere.

I. Introduction, 608. — II. Elements of a model of inheritance, 610. — III. Primogeniture, 612. — IV. The mating function, 614. — V. Random mating, 616. — VI. Class mating, 620. — VII. Assortative mating, 623. Every generation regards as natural the institutions to which it is accustomed. — R. H. Tawney

With emphasis on the adjective and the normative verb should, my answer to the question of this session is a resounding yes. Indeed, I spent a good deal of time between January 1993 and January 1996 acting on the belief that there is such a macro model; so I certainly hope it exists.' This believable falls well short of perfection, leaves many questions unanswered, and is subject to substantial stochastic errors. Nonetheless, it is both useful and extensively used in policy analysis, where contact with reality is a necessity, and you cannot beat something with nothing. It also closely resembles, but does not quite match, the way macroeconomics is taught to beginning and intermediate (but not to graduate) students. In this short presentation, I will describe briefly the main practical elements that I think we should agree on, without worrying too much about their theoretical underpinnings. Then I will turn to two critical failings of the standard macro which cry out for theoretical and empirical repair. My organizing principle is the textbook exposition that has been standard, though not universal, in teaching intermediate macroeconomics for years. The question is: how does it differ from the core model used in policy analysis?

In one of those marvelous coincidences of intellectual history, Robert Lucas was born the year after the publication of Keynes' General Theory. For the first thirty-five years of their mutual lives, the two apparently coexisted in harmony. But their relationship has been tumultuous ever since. Lucas has frequently criticized Keynesian economics as poor science; and it is precisely in that spirit that I want to address the debate today. We all know the old joke about the professor who uses the same exam questions year after year, but changes the answers. That joke encapsulates all too well what has happened to macroeconomics these last fifteen years and seems to reflect poorly on economics as a science. Or does it? On second thought, the best answers to scientific questions do change as new observations are made, as new experiments are run, and as better theories are developed. The issue is whether the answers to important questions in macroeconomics have changed for good scientific reasons or for other reasons. The joke provides the framework for my talk. I will pose eight exam questions; and for each one I will summarize the answers given by Keynes, by Lucas and his followers, and by modern Keynesians. I pick only questions that are answered differently by Keynesians and Lucasians and that are central to contemporary macroeconomic debates. The focus is on whether the Keynesian or new classical answers have greater claim to being scientific. Each student must answer every question. I. Are Expectations Rational?

Both economic theory and casual empirical observation of the U.S. economy suggest that spending propensities from temporary tax changes are smaller than those from permanent ones, but neither provides much guidance about the magnitude of this difference. This paper offers new empirical estimates of this difference and finds it to be quite substantial. The analysis is based on an amendment of the standard distributed lag version of the permanent income hypothesis that distinguishes temporary taxes from other income on the grounds that the former are "more transitory." This amendment, which is broadly consistent with rational expectations, leads to a nonlinear consumption function. Though the standard error is unavoidably large, the point estimate suggests that a temporary tax change is treated as a 50-50 blend of a normal income tax change and a pure windfall. Over a 1-year planning horizon, a temporary tax change is estimated to have only a little more than half the impact of a permanent tax change of equal magnitude, and a rebate is estimated to have only about 38 percent of the impact.

This paper investigates whether and how the distribution of income affects the fraction of disposable income which is consumed. It is shown that a slight generalization of the permanent income or "life-cycle" model of consumption makes each individual's lifetime marginal propensity to consume a fraction of his lifetime disposable resources unless two taste parameters are equal. In considering what this implies for the aggregate consumption function, the tenuous connection between theoretical constructs and observed facts is stressed. Previous empirical work on the subject is criticized for failing to define properly either "income distribution" or "consumption," and a new test, based on the theory, is outlined. Because of data limitations, a number of compromises with this ideal test must be made, and several alternative models are estimated. On the whole, they suggest that equalizing the distribution of income would either leave aggregate consumption unchanged or diminish it slightly.