In this chapter a conceptual framework developed from the insights of X-efficiency (XE) theory is employed to analyze the behavior and performance of the Fed. Our analysis makes two major points of departure. First, the extreme public-choice and neoclassical perspectives are regarded as limiting cases. In our framework, the Fed attempts to strike a trade-off between (1) increasing its own organizational welfare (publicchoice perspective) and (2) increasing public welfare (neoclassical perspective). Second, from the perspective of XE theory, we regard completely optimal behavior by the Fed as a limiting case, because this perspective allows for the existence of behavior that is less than completely optimal behavior, or X-inefficient behavior. However, this contention does not imply that Fed policy-makers are selfish or incompetent. X-inefficiency is a ubiquitous phenomenon that exists (at least to some degree) in almost all organizations, in spite of best intentions and vigilance. The precise extent of X-inefficiency in an organization may be controversial. Its potential existence should not be ruled out on a priori grounds.

Ideally, this assertion should be backed by numerous examples of Xinefficiency in the Fed. However, because there is always considerable controversy about the precise optimal monetary response in a specific situation, it is difficult to assert with certainty that a given Fed response or behavior is X-inefficient. Janis and Mann (1977) concede that within an organization, frequently it is impossible to carry out adequately controlled field experiments that permit unambiguous determination of the causal impact of alternative decision-making styles and procedures. Our problem is even more intractable because the responses themselves are controversial.