The policy choices and reaction functions of bank of England MPC members.

AuthorHarris, Mark N.
  1. Introduction

    In May 1997 decisions on UK monetary policy were delegated to a Monetary Policy Committee (MPC), and in a move toward transparency, a decision to publish the voting record shortly after each meeting was taken. Releasing such information into the public domain has focused parliamentary, financial, and news media interest on the voting behavior of individual MPC members, who are mandated with hitting a government-set inflation target. Split decisions constitute stories in themselves, (1) and it is commonplace to draw attention to differences in votes cast by members appointed from within and outside the ranks of Bank of England staff (hereafter referred to as "insiders" and "outsiders," respectively).

    In this article, it is demonstrated that a member's type--which here refers to the insider-outsider distinction--has a substantial bearing on the policy choices of MPC members. As in previous work (Gerlach-Kristen 2003), insiders can (still) be construed as behaving more "conservatively" than outsiders, choosing higher interest rates. Furthermore, the extent to which each group engages in bloc voting is evidenced, confirming the suggestion that whereas insiders vote as a "cohesive homogeneous group" (Edmonds 1999) outsiders are less inclined to do so. (2) Descriptive statistics show that insiders are also more likely to find themselves on the winning side of a policy decision and are less likely to vote to change the interest rate. These simple results reinforce the outcome of an econometric exercise suggesting that insiders and outsiders have different reaction functions: Although the inflation forecast (expressed as a deviation from target inflation) is a highly significant factor in driving votes to change the interest rate across both groups, insiders and outsiders differ in their responses to these deviations; furthermore, the role of real output growth forecasts (expressed in deviation form from assumed potential output growth) play, at best, a negligible role in determining insiders' and outsiders' voting decisions. Finally, the effect of past voting behavior and policy decisions on current behavior is more pronounced for outsiders; whereas, the effect of different MPC chairmen is insignificant for both groups. Findings are based on voting data contained in the Minutes of Monthly Meetings from June 1997-May 2006, a period characterized by 109 meetings in which 955 votes were cast. It covers the first nine years of the MPC, encompassing the entire period for which the MPC was chaired by Eddie George and the first three years of meetings under his successor, Mervyn King.

    In light of the findings presented here, it is suggested that the MPC is characterized by a structure that leads to insiders dominating decisions. This is no moot point. Although the presence of outsiders is designed to ensure that "the MPC benefits from thinking and expertise in addition to that gained inside the Bank," (3) such perceived benefits can in practice be limited if the structure of the MPC is such that a single group within the committee is able to systematically dominate interest rate decisions. Consequently, the benefits to UK monetary policy from delegating interest rate decisions to a committee are not being fully realized--that is, if one assumes the rationale for establishing a MPC is to engender policy decisions that reflect a heterogeneity of views.

  2. Rationalizing MPC Voting

    There are strong reasons to suppose that the voting behavior of insiders and outsiders will differ. First, as members of the same organization, insiders could have more of an incentive to agree with each other at MPC meetings: Voting against one's peers might be perceived as detrimental to future career advancement. (4) For this reason, it might be predicted that insiders will vote together as a group. Outsiders might not face similar pressure given they emanate from a wide array of different organizations. Buiter (1999) also suggests insiders' votes might reflect an organizational consensus or "Bank" view. Second, members within each group may hold different beliefs about the macroeconomic effect of the timing of decisions, a view supported by the publication of the Minutes in the "Tactical considerations" and "Immediate policy decision" sections. On this view, insiders and outsiders might share the same policy objective (i.e., to hit a government inflation target) but try to achieve it in different ways. Third, different members may base their voting decisions on different information sets: For example, outsiders might attach less importance than insiders to forecasts generated by the Bank's suite of in-house forecasting models. There is evidence to corroborate this view: Sushil Wadhwani (2002) suggests that during his time as an MPC outsider, the Bank models incorporated "too pessimistic" a view about the level of potential output; Wallis (2002) suggests that the Bank's quarterly inflation projections systematically overpredicted future inflation, a fact that is also recognized in the Minutes for August 2000 (p. 9). If other outsiders held similar opinions and if one assumes that insiders were more wed to the Bank's in-house forecasts, it might be predicted that of the two groups, outsiders would ceteris paribus vote for lower interest rates.

    Some of the arguments cited above have been used to account for findings in the literature that examine MPC voting behavior. (5) Gerlach-Kristen (2003) shows that disagreements between members of the Bank's MPC are typically the rule and not the exception. Between June 1997 and April 2003, insiders dissented far less frequently than outsiders, and whereas insiders dissented overwhelmingly on the side of monetary tightness, outsiders did so on the side of monetary ease. According to one argument, outsiders might attempt to raise their public profile by dissenting, in that it attracts media attention. By contrast, insiders might not only dissent less because of an organizational consensus, as in Buiter (1999)--which could promote bloc voting and voting against the majority less frequently--but disagreeing with one's colleagues on the MPC might hamper career prospects at the Bank. This view can be traced back to, for example, Havrilesky and Schweitzer (1990), who propose that the presence of career concerns is an important factor determining the decision to dissent on the U.S. Federal Open Market Committee (FOMC). In this sense, the way a member "performs" on the MPC is not just measured as their ability to hit an inflation target, so to speak, but judged according to their propensity to agree with members of his or her type. Building on this work, Harris and Spencer (2008) investigate the effect of MPC members' career backgrounds and experiences on dissent voting. Econometric estimates suggest that career effects are negligible, with the largest determinant of a member's decision to dissent being their type. Another strand of MPC literature has exploited the heterogeneity in members' votes to predict future monetary policy decisions (Gerlach-Kristen 2004) and shed light on the factors underlying MPC decision making (Bhattacharjee and Holly 2004). In both contributions, information contained in the voting record increases the predictability of monetary policy decisions.

    The MPC's reaction function has also been the subject of academic interest. Chevapatrakul, Mizen, and Kim (2003) argue that the MPC does not follow simple "Taylor-style" rules when setting monetary policy; rather, it uses a broad set of information variables when making a decision. With the use of ordered probit analysis, Gascoigne and Turner (2004) find evidence that the MPC's reaction function is asymmetric. Besley, Meads, and Surico (2008) show that although MPC decisions are marked by voter heterogeneity, reactions to the inflation forecast and output gap are not significantly different on the basis of a member's type and career experience. Finally, Goodhart (2005) suggests that the inflation and real output growth forecasts published in the Bank's quarterly Inflation Report are not those of most relevance in explaining the MPC's policy decisions, in that they are conditioned on the interest rate prevailing after the policy decision has been taken (i.e., they are ex post forecasts). To overcome this problem, Goodhart constructs a series of ex ante forecasts that are closer to the ones on which policy decisions are based. Reaction function estimates with the use of this data suggest that the MPC acted aggressively to deviations in inflation from target. Given Goodhart's experience as an MPC member, his argument has particular saliency. His approach is revisited in the construction of the variables used in estimation.

    Finally, with respect to the UK monetary policy framework, the classification of monetary policy committee types by Blinder (2007) into autocratically collegial, genuinely collegial, and individualistic varieties has particular saliency. According to this typology, the Bank of England MPC emerges as being individualistic, attributable to the fact that during the course of meetings, unanimity is neither necessarily expected nor sought, and members "not only express their own opinions verbally, but probably also act on them by voting" (Blinder 2007, p. 119). The influence of the chairman is thus identified as being less pronounced than for collegial committees (such as the FOMC and the European Central Bank Governing Council), wherein the role of the chairman in shaping decisions is deemed much greater. With respect to the typology of committees outlined above, Gerlach-Kristen (2008) is notable for extending the work of Blinder (2007) to a more formal setting, with emphasis on the role of the chairman.

  3. MPC Framework and Policy Performance

    The MPC is structured as follows: Five members are chosen from within the ranks of Bank staff, hence the name insiders. Three of these members serve five-year...

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