Editor’s note: This essay is an excerpt from the new Hoover Press book Central Bank Governance And Oversight Reform.
Monetary policy is conducted by individuals acting by legislative remit in an institutional setting.
Great attention is paid to the individuals atop the largest central banks. Central bankers today are decidedly recognizable public figures. Some might even be called famous. Their newfound status, however, would make them thoroughly unrecognizable to their predecessors.
The central banks’ responsibilities—the legislative remits with which they are charged—are also subject to considerable scrutiny. Monetary policymakers are tasked with keeping fidelity to their legislated mandates. Some, like the European Central Bank (ECB), are granted a single mandate, namely to ensure price stability. Others, like the Federal Reserve, are tasked with a so-called dual mandate, which includes ensuring price stability and maximum sustainable employment. The financial crisis resurrected yet another objective: ensuring financial stability.
Considerably less attention, however, is paid to the institutional setting in which the policymakers meet, deliberate, and ultimately decide on policy. These institutional dynamics alone are not determinative of the policy outcome. But I posit that the institutional dynamics influence policy decisions more than is commonly appreciated.
In business, academia, and government, people and policy converge in institutional settings. These settings matter considerably to the ultimate success—or failure—of an endeavor. An institution’s setting is a function, in part, of its institutional design; that is, the way in which the entity is originally composed and comprised. But institutions are not static. They change with prodding, time, and experience. An institutional setting, thus, is also a function of the personalities populating it, actions undertaken, and cultures which endure.
Inside the marbled walls and grand columns of central banks lie rich histories and deep traditions. When new central bankers are sworn into office, they arrive with predispositions and preferences. But they get acclimated, in varying degrees, to the institutional setting. And for certain leaders, the institutional setting acclimates, at least somewhat, to them. Public policy decisions are ultimately affected by a mix of people, processes, ideas, and settings. Committees tasked with conducting monetary policy are not immune.
I will consider the institutional setting in the conduct of monetary policy. I review the academic literature, describe my own experience as a member of the Federal Open Market Committee (FOMC), and draw upon a recent study of the Bank of England’s Monetary Policy Committee (MPC).
In 2014, I was asked by Governor Mark Carney, on behalf of the Bank of England, to undertake an independent review of the transparency of its decision-making. The report, Transparency and the Bank of England’s Monetary Policy Committee, issued on December 11, 2014, assessed the transparency among monetary policy committees in advanced economies. I benchmarked the Bank’s transparency to its international peers and recommended certain reforms. In the course of the review, I listened to the discussions of the MPC and met with most members who served on the committee since 1997. The assignment gave me a valuable—and rare—insight into the workings of the Bank’s MPC and made for ready comparison to my own experience at the FOMC and that of my predecessors, captured in part by the published transcripts of FOMC meetings.
The MPC and FOMC have much in common: operational independence from the fiscal authorities, a commitment to price stability, and a strong reputation for integrity of its people and rigor in its analyses. But the institutional dynamics differ across these policymaking committees.
How consequential is a policymaking committee’s institutional dynamics to its ultimate decisions? What happens when its people and practices meet amid uncertainty to deliberate and decide upon a policy choice? Is the committee fashioned to foster robust deliberations as part of its decision-making process? Or do the dynamics disincline its members from changing their a priori judgments? To what extent does the committee design foster groupthink? Or does it favor a diversity of views?
These questions cannot be answered definitively. But understanding the institutional dynamics inside monetary policy committees is likely as consequential to sound policy decisions as the skill of the people who lead the committees and the remits they are obliged to follow.
Scholars and practitioners in the fields of management and organizational design have much good work to share with central bankers. The lessons learned from these other disciplines are quite applicable to the evaluation of monetary policy committee dynamics.
Institutional dynamics have an important bearing on the long-term success of an organization. In their survey of the academic literature, Mellahi and Wilkinson (2004) describe two broad models to account for organizational success or failure. One identifies “external factors” as the predominant force—failure of particular organizations is predominantly a symptom of an industry-wide decline of which management’s control is limited. An alternative theory emphasizes the importance of “internal factors,” that is, the quality of management decisions and the institutional settings within which they are made.
The literature identifies numerous interrelated theories that link internal management inadequacies to organizational failure. These include:
- Janis’s canonical Groupthink theory (1972, 1982), which highlights the tendency of small, homogenous management teams to make suboptimal decisions;
- Hambrick and Mason’s Upper Echelon theory (1984), which links organizational achievements to the composition and background of an organization’s senior management team;
- Staw, Sandelands, and Dutton’s Threat Rigidity Effect theory (1981), which explains the tendency of management groups to stick rigidly to tried and tested techniques at times of threat and challenge, thereby increasing the risk of organizational failure among incumbents at times of secular change.
The common finding is to tailor institutional settings—that is, the design of decision-making processes and structure of decision-making groups—so that genuine deliberation prevails. This is particularly important in times of regime change in the data or policy paradigm.
That genuine deliberation should play a central role in decision-making is rooted in classical liberalism. John Stuart Mill (1859) championed the importance of free speech and discourse to intellectual progress. He advanced the belief that truth would emerge through the free competition of ideas in public discussion and debate. As Mill wrote in his classic On Liberty: “The general or prevailing opinion in any subject is rarely or never the whole truth; it is only by the collision of adverse opinions that the remainder of the truth has any chance of being supplied.”
A core aim of deliberation is to achieve consensus among different parties. But, as noted by Barabas (2004) and others, deliberative processes should accomplish more than merely achieving consensus. Barabas defines “desirable” (or genuine) deliberation as that which succeeds not only in achieving consensus, but also in delivering intellectual progress: “Submissive consensus is clearly undesirable . . . [t]o be desirable, deliberation should improve knowledge so that participants come not only to a consensus, but also to an enlightened view of the problem at hand.”
Genuine deliberation is, therefore, the process by which participants not only share information, but also learn from and influence one other. It is the crux of good decision-making processes within both public and private spheres, the “special sauce” to optimize policy.
As Schonhardt-Bailey (2013) describes in her comprehensive analysis of monetary policy deliberations: “Effective deliberation among . . . unelected experts who are being held to account is thus one of engagement and reciprocity where participants talk to one another and take up others’ points.” The institutional setting should allow genuine deliberation to flourish.
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