Research on the UK’s influential Monetary Policy Committee reveals a divide, with insiders as fiscal hawks and outsiders evolving into doves. Michael McMahon and Stephen Hansen explore the reasons behind the phenomenon and examine the broader implications for a world that relies on such panels for most important economic policy decisions.
Only days after the UK’s parliamentary elections in May, the coalition government’s Chancellor of the Exchequer announced the creation of a new, independent committee to produce the economic forecasts that underlie the nation’s fiscal policy. The decision represents a historic departure for the UK, where the government’s economic forecasts have long been fashioned in an atmosphere lacking in transparency and ripe with political influence. The announcement provided a timely example of a dramatic change that has occurred over the past two decades as governments around the globe increasingly hand over important economic policy decisions to committees of experts.
Our research attempts to gain insight into the dynamics that can affect the decisions of these increasingly influential economic policy groups. Our work examining the voting patterns of the UK’s Monetary Policy Committee (MPC) finds striking and unexpected differences emerge between members depending on the nature of their appointment, as an insider or outsider. Surprisingly, our research finds very little support for the idea that outsiders begin to take a different stance because of learning and increased expertise gained over the early part of their tenure. Instead our research suggests that the outsiders begin favouring lower interest rates as the result of a changed philosophy. A likely source of their evolving view appears to be long-term career interests of the outsiders.
Despite similar backgrounds and expertise, MPC insider and outsider members vote differently. After a year on the panel, outsiders favour lower interest rates
The MPC was established in the wake of the 1997 Labour party landslide, when Gordon Brown, then the new Chancellor of the Exchequer for Tony Blair’s administration relinquished his power to set interest rate. The goal of the MPC was to make monetary policy less arbitrary and less susceptible to election cycles. Its objective is to maintain price stability and enhance growth and employment. In practice, the committee seeks to achieve a target inflation rate of 2 percent, based on the Consumer Price Index. If inflation is greater than 3 percent or less than 1 percent, the Governor of the Bank in England must write an open letter to the Chancellor explaining why. Missing the target in either direction is treated with equal concern. Members are urged to vote for the interest rate they believe is most likely to achieve that target.
The Chancellor of the Exchequer appoints four of the nine MPC members from outside the Bank of England--the external members. The five internal members come from within the central bank. All members have expertise in economics and monetary policy. Each member is independent in the sense that no one represents any interest group or faction.
Our analysis of the MPC’s voting record uncovers an unusual pattern: We find that after a year on the panel external members start to vote for lower interest rates. Thus, the outsiders evolve into “doves,” while the insiders remain “hawks,” wanting to control inflation at all costs.
This divergence is especially surprising because members of the committee often have such similar backgrounds and expertise that they could plausibly serve interchangeably in either role. This striking “delayed dovishness" is present, even when we take account of any differences in members’ backgrounds, age, education, as well as the current macroeconomic environment. The nature of one’s appointment, as insider or outsider, determines the course a member takes. Thus, our findings underscore that the composition of the committee can have important and unexpected effects.
Surprisingly, the outsiders’ voting pattern is unrelated to on-the-job experience. Instead, long-term career concerns seem a likely cause
One possible explanation of the external members’ change in voting behaviour relates to the external members growing in expertise. After a year on the panel, they may feel more comfortable about expressing an opinion or more confident in voicing divergent opinions. Another explanation relates to a change in their underlying view of the necessary interest rate to achieve the inflation target. As they serve longer on the committee, external members may begin to believe that lower interest rates are compatible with inflation at the target rate. This explanation suggests that something affects external members’ preferences or philosophy.
In order to try to disentangle these effects, we use a simple model that provides a prediction about how each member is likely to vote. Our model predicts that voting behaviour responds differently depending on whether the choice of interest rate is clear-cut or subject to greater uncertainty. Using market information collected in the days before the decision, we examine the voting behaviour of external and internal members under different degrees of decision “straightforwardness.”
When we compare our estimated voting behaviour with the predictions of our model, the result is clear. Surprisingly, there is limited evidence to support the learning explanation. The voting behaviour of the externals strongly suggests the effects of a change in preferences, or of economic philosophies that underpin their view of the situation.
One plausible reason for an evolution in outsiders’ philosophies appears to be career concerns. The external members may wish to signal their expertise or their economic philosophy. Members may be concerned by the effects of their votes on their reputations. For example, they may want to signal particular preferences to the private sector in order to “line up” more opportunities for themselves at the end of their time on the MPC.
The worldwide trend toward consolidating economic influence among multi-member panels raises a basic and as-yet unanswered question: What is the ideal group? No one yet knows what the optimal composition of committees such as the recently formed Office for Budget and Responsibility, which will be chaired by Sir Alan Budd and will include two other members, all independent of the Treasury.
Yet, as our findings underscore, the composition of the committee matters, and matters a great deal. Better understanding the forces at work and how they sway individual members’ outlook could affect policy and design of the MPC, the OBR, or other similar committees.
Michael McMahon is Assistant Professor in Department of Economics at Warwick University. Stephen Hansen is Assistant Professor in the Department of Economics and Business at Universitat Pompeu Fabra.