Comparing Central Banks with Competition authorites

John Vickers, former BoE member and now at Oxford writes this superb paper on the topic. I have always wondered on comparing central banks with other economic institutions. THis one compares the competition authority with central banks.

Interestingly, in both competition  and monetary policy there was a consensus to follow the neoclassical model till this crisis. Now things have changed a bit. Vickers writes about this change:

The establishment of independent authorities for monetary policy and for competition policy was part of the institutional consensus of the Great Moderation. The paper contrasts how policy has operated in the two spheres, especially as regards the role of law. It then discusses the application of competition policy to banks before and during the crisis, and relationships between competition and financial stability. Finally, the paper considers whether the financial crisis – which has led, at least temporarily, to unorthodox and less independent monetary and competition policies – has undermined the long-term case for independence. The conclusion is that it has not. While regulation of the financial system clearly requires fundamental reform, sound money and markets free from threats to competition remain fundamental to long-run prosperity; those ends are best pursued by focused and independent monetary and competition policies.

Overall Vickers says nothing much has changed since the crisis and we need to focus on basics. But this comparison between competition policy and central banking is so so interesting. Both BoE and UK Comp Policy were reborn in 1998:

The UK is a prime example of the adoption of this institutional consensus. The Bank of England Act 1998 and the Competition Act 1998 (soon followed by the Enterprise Act 2002) brought forms of independence to decisions in the spheres of monetary policy and competition policy respectively 300 years after the foundation of the Bank of England and 50 years after the creation of the UK’s Monopolies Commission. Previously, decisions on both fronts had ultimately been taken by government ministers, with interest rates set by the Chancellor of the Exchequer, and important decisions (eg on remedies) in monopoly and merger cases being taken by the Secretary of State for Trade and Industry.The two pieces of 1998 legislation gave the monetary and competition authorities powers to take policy decisions independently from ministerial government, albeit with the inflation target set (transparently) by the Chancellor of the Exchequer.

What were the rationales and pre-conditions for independence? What forms did it take? What do independent monetary policy and independent competition policy have in common? What are the contrasts?

He says the broad idea is based on BoE as hedgehog taking one major action and Comp Policy as a fox taking many small actions. So BoE conducted mon pol using one major act interest rate decision and Comp policy does many small actions as each case is different.

What is the rationale for independence of both?

In respect of both competition policy and monetary policy, therefore, the rationale for independence has two strands. One concerns comparative advantage. If competition [monetary] policy is seen as being much better at maintaining competition [price stability] than say employment, then it makes sense to focus it on that to the exclusion of other objectives. In that case the operation of policy can be delegated, relatively uncontroversially, to technocrats independent from political intervention. The other strand has to do with commitment – to no inflation surprises from monetary policy and, in a multi-country system, to resistance of certain kinds of anti-competitive policy at national level. The strands are related because the devotion of monetary policy instruments to price stability and of competition policy instruments to the protection of competition is in part a commitment that other considerations do not count in decisions about how those instruments are set.

What are the differences? he highlights six areas – simplicity, exclusivity, repetition, accountability, information, and interested parties. Read the paper for details on each.

In summary, independent monetary policy and independent competition policy operate in very different ways. The monetary authority, which alone has a decision-making monopoly in its currency area, regularly and repeatedly chooses a one-dimensional instrument (in normal times) on the basis of largely public information to achieve a single target, unchallenged by vested interests. The independent competition authority works in a system of law, making decisions, sometimes with long-lasting effects, about a variety of business practices in diverse markets, often on the basis of confidential information, under multi-faceted competition law, the meaning of which evolves and is not always clear, which others can also seek to apply, and subject to well resourced challenges from interested parties, especially in court, where ultimate power lies with the independent judiciary.

Monetary policy is of course not the only task performed by central banks. Many are responsible also for (micro)prudential and other financial regulation, an area of policy in which law and therefore lawyers can be prominent. An interesting question for the future, as institutions of macroprudential regulation develop, is whether or not it will operate essentially free of legal constraints, like monetary policy. Although the aim of macroprudential regulation is to be countercyclical over time, its operation could substantially affect the relative efficiency and profitability of different business models at different times.25 In short, and whether or not it enters legal forums, macroprudential regulation could well affect competition.

Superb stuff. Linking these two different institutions gives you a different perspective.

Vickers then looks at other issues of competition vs. financial stability and whether crisis leads to loss of independence. In the end he summarises:

The crisis has shaken many established beliefs about the appropriate relationship between the state and markets. Above all, the regulation of the financial system clearly requires fundamental reform. The crisis, and measures taken to stem it, have also raised serious questions about relationships between the political process and organisations within the state such as central banks and competition authorities. The independence of such bodies always was a more complex, diverse and multi-faceted issue than it may have seemed in the good times. As we have seen, independence has taken very different forms in monetary and competition policy, and degrees of independence vary over time, both backwards, as of late, and forwards.

In sum, prospects for the independence of monetary and competition (eg merger) policies post-crisis may depend above all on the answers to two questions. Are sound money and free markets still (appreciated as being) fundamental to long-run prosperity? Are there other important objectives that monetary and competition policies can usefully pursue in addition to price stability and markets free from threats to the competitive process? My answers, in short, would be yes and no respectively, but the political debate may result in different conclusions. In any case let us hope that it is influenced by good economics.

We hope too. Though sticking to good economics is always difficult to apply. What is good economics also changes from economist to economist. So, we are more likely to have a sub-optimal structure.