Design of an optimal monetary-policy committee..

I pointed to a column earlier which criticized FSLRC’s proposal to set up an MPC in RBI. The criticism was based on the fact that MPC would become a politicised body and lead to excessive govt interference.

Keeping this criticism aside for a moment, say govt goes ahead with MPC for RBI. What should the design be? More of RBI people? More of Academicians? More of Industry People?

This column by Sylvester Eijffinger, Ronald Mahieu and Louis Raes looks at design of MPC:

One important practical aspect of monetary-policy concerns decision power and its accompanying responsibility. Most central banks have moved towards a structure in which decisions are taken by a committee. Pollard (2004) provides an early survey in which 79 of 88 surveyed central banks are governed by a committee.

However, even with a committee that is responsible for decisions on monetary policy, many options are possible. Blinder (2007) discusses some aspects that drive what is chosen from these options. One aspect which has received a lot of attention in the academic literature concerns whether a committee should be composed of people who have worked at the central bank or not, or a mix of both. Related to this is the question of whether it is desirable to appoint central bankers who have relevant experience in sectors like the financial sector, the NGO sector or working as a civil servant. The idea is that bringing some particular career experience to the table provides additional knowledge to the committee.

So far, the academic literature has been inconclusive on these matters. We report here on recent research which sheds some light on these issues. Two papers estimated policy preferences of central bankers within a spatial voting model, Hix et al. (2010) and Eijffinger et al. (2013). This spatial modelling approach was previously developed by scholars investigating judicial votes or votes in the US congress and has substantial advantages over the traditional methods economists have used to tackle these questions. The approach is both easy to implement and flexible. To our knowledge only the above two papers have tried to implement this method in the context of voting at central banks. The former paper focuses on the political appointment channel. The latter paper focuses on the questions stated earlier and fits in the literature investigating the composition of monetary-policy committees, see Besley et al. (2008) for a recent review.

The paper draws insights from observing how BoE MPC members have voted over the years. They divide the members based on backgrounds and list them on dove-hawk scale. This helps figure which member votes how..

Findings of their paper:

  • First of all, these results confirm some findings in the literature, in particular that it is not the case that externals are simply more hawkish or dovish than internals.
  • Also, career backgrounds do not simply correlate with preferences on a dove-hawk dimension.

Both these results resonate with the findings from Besley et al. (2008). Because we can identify the policy preferences of individual central bankers it is easier to understand how certain results come about.

  • A new finding is that the variation in preferences changes with career backgrounds;

This is intuitive. If you have worked for years at the Bank of England it is likely that you share some organisational consensus. An academic on the other hand has worked in an environment where having an opinion (and especially a pronounced opinion) is valued. But the implications hereof are important. There may be different reasons to have a committee in place. If one of these reasons is that a wide range of policy preferences should be included in a monetary-policy committee then having sufficient academics in the committee might be a reasonable strategy.

Hmm…Getting more academicians in MPC seems to have worked for BoE..

The empirical research discussed in this column builds on a latent variable framework in which monetary policymakers are ranked on a dove-hawk dimension. Some may feel that this is too restrictive and that a multidimensional framework is more suitable to capture voting behaviour. From a theoretical point of view we certainly agree. However the results presented in our paper (Eijffinger et al. 2013) as well as in Hix et al. (2010) suggest that a single latent dimension fits the observed votes quite well. In other words one does not need to complicate the modelling approach by introducing multiple latent dimensions to predict observed votes. In practice the single dove-hawk dimension seems adequate.

What about other central banks? Can we really take BoE as a standalone case. We need to use the approach for other central banks as well which have MPCs as well…

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