Designing monetary policy committees, revisited

(This post is likely to interest only those with a relatively detailed interest in the reform of the Reserve Bank.)

A month or so ago the Minister of Finance announced the outline of his planned legislative reforms of the monetary policy provisions (objectives and decisionmaking) of the Reserve Bank of New Zealand Act.  According to the material released then

What are the next steps for progressing the outcomes of Phase 1 of the Review?
Officials will advise the Minister of Finance on detailed implementation issues associated with the high-level Phase 1 decisions by late May.

so presumably Treasury is beavering away at present, with the Reserve Bank chipping in to try to retain as much effective control with the Governor and his management team as possible.  Unless, that is, the new Governor is taking a quite different –  and more open and legitimacy-focused –  approach than the Deputy and Assistant Governor he inherited from Graeme Wheeler.   Legitimacy is a key focus in a major new book (Unelected Poweron the institutional design of central banks –  and other autonomous government policy/regulatory agencies – published a week or so ago, and written by Paul Tucker former Deputy Governor of the Bank of England.

I’ve written various posts on aspects of the detailed design issues.  And in a post last week, I dealt with a recent conference presentation on these and related issues by two former central bank officials, one of whom was David Archer, former Assistant Governor (and successively head of financial markets and head of economics) of the Reserve Bank, and now head of the department for central bank studies at the Bank for International Settlements (a “club” for central banks).

I’ve been learning from –  and often disagreeing with – David for almost 35 years now, since he was briefly my boss in my first year out of university, when I was tossed a paper he was writing on reforming the operational aspects of monetary policy and asked for my comments.  He was my boss in a couple of other stints, and then for most of his last few years at the Reserve Bank, he was head of economics and I was head of financial markets.  Frustrating as he could sometimes be –  and I’m sure the sentiment was reciprocated at times – I reckon that in many respects he’d have made a pretty good Governor, at least of a monetary policy focused central bank.  These days he has the advantage of moving among a bunch of very able experts, and perhaps the disadvantage that those people are mostly insiders (formally or not), and his employer is an organisation that doesn’t need to worry much about legitimacy.  Readers may think I’m given to idealism, but on a pragmatism-idealism scale, I’m further to the pragmatic/political end of the spectrum and David towards the idealistic/technocratic end.

As I hope was apparent in post last week, there is a great deal David and I agree on in the context of designing laws, and associated rules, for monetary policy.

  • moving away from a single decisionmaker model (an innovation in the 1989 Act that no one chose to follow, and which has become increasingly less appropriate),
  • that public confidence in the legitimacy of the institution is crucial if operational independence is to be sustained,

Thus far, most people would agree. But we go further:

  • groupthink is a serious risk in any institution, and in any Monetary Policy Committee, and groupthink can seriously undermine the advantages of establishing a committee,
  • free-riding is also a risk in any such committee, and thus
  • a Monetary Policy Committee should have a clear majority of outside members,
  • and those members should be individually accountable for their advice and their vote,
  • a diversity of views/perspectives should be sought, and encouraged (consistent with the high degree of uncertainty and the risks of groupthink in any institution),
  • a role for parliamentary scrutiny (in my case) or approval (in David’s) for people nominated to serve on an MPC,
  • proper and substantive minutes of MPC meetings should be published, with no more than a short lag.  Such minutes should capture and convey the differing perspectives that individual members bring to the discussion (whether about specific OCR decisions, or the approach the committee is taking to monetary policy).  A parallel exists in the form of the range of (majority and minority) opinions judges of higher courts often deliver in deciding cases.
  • individual MPC members should be free to give speeches or interviews articulating their perspective on monetary policy issues, and not be bound to present only a majority institutional view,
  • appointment terms should be staggered, and of a significant length.   David favours prohibiting reappointment, although I’m more hesitant about going that far (because very long term weakens the effective accountability we both seek).
  • periodic external reviews of monetary policy have an important role to play, and should be an established feature of the system (rather than, say, a response to specific episodes of discontent).

Since my post last week, David and I have been exchanging notes on a couple of the issues where our views diverge.  (There are probably others –  while I’d not be averse to a single non-New Zealand member of an MPC, David would  – on past form –  be more open to a larger foreign participation.  For me, one element of legitimacy is about –  in Paul Tucker’s phrase –  perceptions of “values compatibility”.  The New Zealand public need to be confident that an autonomous central bank is working for them, and that is more likely –  at the margin – when the decisionmakers are themselves drawn from that community).  David has given me permission to quote from our exchange.

In my earlier post, I quoted from the Archer/Levin slides

The MPC should formulate a systematic and transparent strategy that guides its specific policy decisions over the coming year or so.

and observed

Easy enough to write down, but hard to make it mean anything particularly specific.

In response he noted (emphasis and link added)

As in my comments on Rennie, and as in Andy’s presentation, I see 3 layers for policy. Call them framework, strategy and tactics. They correspond roughly with what goes into a PTA; the policy reaction function that goes into the forecasting model (alternatively, a Taylor rule or alternative rule that captures the systematic aspects of policy in pursuit of the target(s)); and the stuff around nowcasting and forecasting. Andy and John Taylor and others argue that the Fed should be articulating its strategy, and disclosing that, though Andy is more open on the form in which the strategy is articulated that John appears to be. You and I argue that the RBNZ should disclose its model, also so that the systematic parts of the Bank’s thinking are on display. We’re all talking about central banks being more open about the systematic elements that are under the their control, to improve discipline and legitimacy.

So I actually think we’re in a similar place. We might disagree on whether a Taylor Rule type of PRF [policy reaction function] “dumbs down” the policy process too much – in my view, the ability of the Taylor Rule (or variants thereof) to capture the essence of policy needs is remarkable and telling, as is the regularity with which departures from TRs have turned out to be mistakes. And we share the view that central banks should be required to explain why they think this time is different, which is helped by having a publicly disclosed benchmark.

We both agreed that forecasting is of little value.

Part of the context here is about proposals in the US to require, by law, the Federal Reserve to publish the reasons why its interest rate decisions deviate from the recommendations of, say, the Taylor rule (a fairly simple, but at times surprisingly useful, guide to how central banks (should/do) run monetary policy (using just a neutral interest rate, an output (or employment) gap, and the gap between the inflation rate and target).  David is more sympathetic to something along those lines than I am, and sees the primary role of an MPC as to formulate and articulate a strategy to guide monetary policy.

In response I wrote

I’m inclined to agree that the Taylor rule seemed to do a remarkably good job for a period, although am less sure of its value in the last 5-10 years, because one of the key questions that central banks have had to grapple with (implicitly or explicitly) is what is happening to the natural interest rate itself –  and Taylor can’t offer useful insights on that.  As you note, I would favour the RB publishing its forecasting model, including the reaction function (as part of much greater sense of input-transparency all round), altho I’m more sceptical about the ability of the reaction function to really represent all the contingencies a committee of policymakers (esp an individualistic one) is likely to have in mind.  I’d probably put more weight on the potential for good minutes –  of the sort you suggest –  combined with a requirement for MPC members to publish their individual estimates of key system parameters (neutral interest rate, NAIRU –  akin to the final observation in the Fed dot-plot) to provide a steer as to thinking, and something later to use for some sort of accountability.

In other words, I’m all in favour of an MPC publishing lots of its inputs (eg the background staff papers it receives) and a lot about individual members’ priors.  Like David, I favour the publication of good minutes.   But I’m sceptical that an MPC can usefully go very much beyond what is captured in a PTA –  the bit the Minister of Finance controls.   There is just too much uncertainty about how the economy works at any particular point in time –  more so in the last decade with a great deal of uncertainty about “the” neutral interest rate – for statements of MPC strategy to add very much value.

Our other area of disagreement seems to be over the type of people who should be appointed to serve on a statutory Monetary Policy Committee.

In his announcement of the proposed New Zealand reforms, the Minister of Finance indicated his view on that issue as follows:

External members will have knowledge and experience in relevant policy areas (such as economics, finance, banking, or public policy). However, members will not be limited to monetary policy experts. External members will need to be free from conflicts of interest and will not be on the MPC to represent a particular sector.

It is worth noting that there is no particular reason to expect that most of the internal members will be monetary policy experts either.  At present, for example, the Governor is chief executive for a broadranging organisation, and may not have had a strong background in monetary policy (neither Brash, Bollard nor Wheeler did), and the current deputy governor is a career public servant with an economics background mostly in labour and fiscal issues.

I wasn’t unhappy with Grant Robertson’s description of the sort of people he expected would be appointed.  But in the Archer/Levin slides, they argued

…..the MPC should comprise a diverse group of experts who are individually accountable for their policy decisions.

To which I responded briefly.

I’m not totally persuaded by the “experts” line myself –  one needs lots of expert input/advice to policy, but when it comes to decisionmaking, soundness is at least as important as cleverness.

To which David responded (we both agreed that the value of outsiders shouldn’t be in bringing a better class of business anecdote to the table –  the role the external advisers play at present)

….the big issues in policy-making, the ones that impact on welfare, concern choices of framework and choices of strategy. Right now, as you also argue, the greatest attention by far should be on whether policy design is right. Do we have the right tools? Can we get interest rates to move enough in response to demand perturbations, without banging into lower bounds? What do we think about the appropriate speed of response? If we had a price level “attractor”, would that help induce stronger responses to negative perturbations that risk acquiring a deflationary dynamic? When might asset prices or other indicators of collective manias sensibly affect policy making? Questions about the variability of the exchange rate come into play in open economies. These are the things that can make a real difference. Tactics don’t. So if we’re staffing a policy committee, we should staff it to be capable of handling such questions, and bring a diversity of approach to the thinking on them. From my observation, it’s in relation to these questions where Group Think has its greatest hold. People find it easy to disagree on timing and tactics, but find it very hard to challenge accepted frameworks.

Hence I come down in favour of a diversity of people with the expertise and inclination to handle evaluations of frameworks and strategy, rather than something aimed to reflect the composition of society or of economic activity. And I acknowledge a cost to that approach: political legitimacy is less readily supported, because the policy committee members are not obviously “like us”.

It is an ambitious vision.  I wasn’t persuaded though

…..where we disagree is whether one looks to the MPC members primarily as expert analysts and decisionmakers/communicators in one, or as customers/purchasers for expert analysis, and then decisionmakers/communicators.  I can’t think of many (any?) bodies in our society that function in the former way.  …..  I guess I”m inclined to think that I want MPC members (including the Governor) who will create a climate that encourages debate, and research, and engagement –  inside and outside the Bank –  on all the sorts of issues you raise, and more, rather than being those experts themselves.  It doesn’t mean I’m opposed to have some genuine experts on the committee, but it might be undesirable (even if enough were available) for them all to be experts. For a start, those people won’t necessarily have the (eg) communications skills a public agency needs, or the institutional political skills.  And realistically, not one of the Governors in my career (here and abroad, …..) has been what I would call a monetary policy expert.   Arguably, none of the deputy governors have been either.  Perhaps that should be changed, but there are pretty slim pickings, and frankly what worried me more about Graeme wasn’t his lack of expert background as his lack of openness to debate/challenge scrutiny.  Realistically also, even if we had resident academics who were strong in these areas, many might be better used –  and themselves prefer –  to be based in the academy, generating research and then interacting with policy people, than devoting large chunks of their time to “tactics” and related stuff.
You also note that “People find it easy to disagree on timing and tactics, but find it very hard to challenge accepted frameworks.”.   Maybe, altho your great chart from the Sept 08 FOMC [reproduced in last week’s post] argues against that (at a time when it counted).
On my telling, an MPC should be a balanced panel of people, dominated by outside non-executives, but drawing on high level technical expertise (staff and outside resources).  Since I favour separating monetary policy and regulatory functions into separate institutions, I would favour seeking a monetary policy expert as Governor (and chief executive).   To me, the parallel is with something like the Cabinet –  drawing on expert advice, sometimes ignoring it completely, without themselves being the experts.   That seems more like the way in which we typically run institutions in our society (a telecoms company board will typically benefit from having some people who really know tech/telecoms but will rarely be exclusively comprised of such people).
David responded, having emphasised his view that frameworks and strategies, rather than specific OCR decisions, are mainly what we want an MPC for.

How does one evaluate alternative frameworks and strategies? With extensive modelling exercises, and empirical evaluation of results of different frameworks and strategies at work in practice in comparable countries. Evaluating, making sense of, and extracting the lessons from such research is thus the main task. The expertise required should be sufficient to evaluate research effectively, but not necessarily to design and conduct that research. What the candidate MPC member needs is sufficient training in economics to understand the research they are being presented with. There’s a specialised vocabulary involved. Different research methods take quite some time to understand, especially in terms of the implicit assumptions involved in the choice of method. Perhaps most importantly, even very experienced lay people struggle to grasp the general equilibrium mind set, which is crucial to comprehending how the macroeconomy responds to various impulses over the time frames relevant to the design of frameworks and strategies.

…. Experts should not be equated with PhDs with great track records for research and publication (though they shouldn’t rule the person out).

I’m not persuaded.  There is certainly a need for plenty of background research, and the synthesising and application of that research to a New Zealand context. But I don’t think decisionmakers need to be literate in the issues in the sort of depth David suggests, and I think there is a real risk that – even if enough such people could be found in New Zealand –  such a panel of people might prove more interested in the esoterica of some of the debates (and the important issues that really matter, like the near-zero lower bound) than about actually making good OCR decisions that deliver inflation consistently at or near whatever target the Minister of Finance has set.  This is a point Paul Tucker makes in his book: reputation is a key element of public sector accountability, but for it to work, the appointed policymakers have to care about the stuff the public is looking for from th institution.   People with a stronger interest in the international conference circuit (I’m caricaturing, but it is a risk) than in short-medium term New Zealand macro outcomes, won’t end up with very much effective domestic accountability.

Tucker also makes a point I’ve made here repeatedly.   Requiring technical expertise to be brought to bear before decisions are made does not mean that the technical experts should be the decisionmakers.   We need to bring a lot of technical expertise to bear around monetary policy (tactical decisions and framework design) but in my view much of that expertise should reside on the staff of the Reserve Bank, and it should be one of the prime roles of the Governor to (a) foster such expertise, and (b) ensure it is exposed to external challenge and scrutiny (and alternative external perspectives) and (c) to ensure the results, and alternative interpretations, are translated into language decisionmakers –  on the MPC –  can make sense of, and can question and challenge (and where those decisionmakers have the incentive to do so).  I’m sure there is a place for some monetary policy experts on an MPC –  including among the externals – but the MPC should no more be dominated by such people than (say) major decisions on war and peace should be made by generals (no matter how valuable their technical advice might be).    Legitimacy is rarely achieved simply by technical expertise.

These are important issues to be thought through in the design of the new MPC for New Zealand, and in the process of making the first wave of appointments (which will establish much of how the MPC works).  In practice, in a New Zealand context (given limited pools of candidates) I’m not sure how far apart David Archer and I would end up being, but I hope Treasury and the Minister are giving some thought to the sorts of issues raised here.


7 thoughts on “Designing monetary policy committees, revisited

  1. Interesting commentary again Mike.

    I’d make two observations. I agree with you that having technocratic experts on the MPC won’t necessariky lead to better outcomes. The observations I’ve had of “shadow RBA” decisions is that they’ve been consistently behind the curve relative to both the Bank and financial market and if they’d been implemented the outcomes would have been almost certainly worse. In addition to a hawkish Bankers hard money stance they’ve typically shown both inertia and very limited willingness to accept the inherent uncertainty associated with policy decisions as shown by their consistent tight grouping of variance in interest rate expectations.

    The second point I’d raise is the appropriateness of the Taylor Rule. As you point out, it’s questionable as to whether it’s been a useful guide to policy post-GFC – regardless of how one corrects for the zero lower Bound – and it’s not clear how one should determine r*. Add in the high sensitivity of a small open economy like NZ to movements in the exchange rate and the Taylor rule becomes even more fragile as a guide to policy.


  2. Oh and i’d also add that we face another issue in NZ; there just aren’t many people either in academia, business or government who have really strong backgrounds in monetary and financial economics. It’s a very thin field these days…


  3. Indeed. Rebuilding that capabiliity internally should be a task for the new Governor, but (a) these things take time, (b) it doesn’t resolve gaps in academe or Tsy, and (c) in many respects the FOMC comes closer to being chock full of experts than most central bank policy committees and as the Archer/Levin presentation illustrated, they were the ones who got things really badly wrong in Sept 08.


  4. It seems to me that much of the debate on the design of MPC and decision-making structures for monetary policy is largely pointless. There is no single right answer to decision-making structures; different models work satisfactorily, as is evident from the multiple models around the world. Like much of the endless debates on these topics, the gains from pontificating on the different details of decision-making structures are likely to be very minor indeed. I doubt that there is any persuasive empirical evidence available that indicates that there are sustainably significant differences in monetary policy decision outcomes as a result of different decision-making models. I can see solid arguments for a committee model over a single decision-maker model, and a marginal case for the committee to comprise a majority of external appointees. Robust disclosure and accountability arrangements are clearly important. However, i feel that the endless articles and debates on this topic, including within the BIS, is a classic case of rapidly diminishing rates of return and, frankly, a questionable use of BIS research resource, especially when there are far more important matters requiring policy attention – not least in the financial stability area and on the efficacy of macroprudential policy. It is staggering that central banks, academics and the like spend so much time on matters that have relatively little practical consequence. Rather like the disproportionate resourcing central banks devote to monetary policy, with little to show for it. Monetary policy is not that complicated, frankly, compared to the many other policy issues where the research boffins would be more productively engaged.


    • With all due respect to David, my own view is that it is a shame that the Bretton Woods agreement to wind up the BIS wasn’t implemented.

      I’m not sure how much resource the BIS devotes to researching such issues – the Levin/Archer presentation wasn’t even a full paper – but one area where it adds value is as a clearing house for information: countries wanting information on how other countries do things, incl what seems to work well (in what circumstances) and what doesn’t.

      I’m not really convinced that monetary policy and macro management issues are less complex etc than many other areas of life (including financial stability). Of course, as in all areas of policy there is both a very simple broadbrush approach, and a more subtle detailed perspective. But there is a tendency in all areas for more and more analytical resource to be devoted to increasingly detailed policies, reinforcing the systematic pro-establishment bias in the system. Monetary policy – incl governance – can be done very simply, but so could many other areas of policy (economic and otherwise), and there are diminishing returns to almost all of them.

      That said, in a NZ specific context I’d be a little surprised if we over-invested in research and policy analysis on almost any front (a reflection of small size I suppose). On these particular issues, it is a once in a generation reform – and even then the amount of NZ taxpayer resource going into these issues seems quite model (esp spread over 30 years). In terms of issues I’m interested in, I guess there is more resource going into these issues than into sorting out our long-term poor productivity performance, but work on one probably shouldn’t be at the expense of the other.


  5. As Geoff mentions, I do wonder about diminishing returns from some of the possible variations. Having said that, I do find it interesting to think about the alternatives.

    I like the idea of having an MPC that aren’t experts in the field, like a board of directors. Perhaps a way to get there would be to start with an MPC of experts in the field, with a planned replacement program over, say, five years to replace members with non-experts. If during that time it was found that it wasn’t working it could easily be changed.

    Another variation would be to have a league table of members based on an assessment of their decisions, with lower performing members being dropped if they are consistently under-performing. For example, someone consistently voting for interest rates to remain the same when inflation was below target would not score as well as someone who voted to drop rates.

    But I don’t believe the above is targeting the right thing anyway. I think the real issue is to have a diverse range of advice into the decision making process. For example, no matter who is on the MPC, if their only source of knowledge is from the RBNZ, then their decision will biased to what the RBNZ believes is appropriate, no matter how hard the advice tries to be neutral.

    I believe having a number of external appointments, whether MPC experts or not, is an informal attempt to bring a diversity of knowledge into the decision making process, so that the RBNZ is not the sole source of advice.

    If I’m right, then a formal goal of the MPC should be to seek a diversity of ideas, and not just use RBNZ advice.

    A further variation to an MPC – could the decision making be left to the markets? Would it be possible to construct a financial instrument(s) that rewarded/penalised investors depending on how close to target inflation is?


    • Scott Sumner is the US argues for something strongly market-based, using futures contracts on nominal GDP. In the end, state fiat money is a direct policy intervention, and whatever information one uses, state actors have to manage its value.

      On the discussion around options, bear in mind that there has been very little serious discussion at NZ taxpayers’ expense in the public domain, even though this is a very powerful public agency. It always tends to suit insiders to cut back on the debate/discussion – or hold it tight under the OIA as happened with Wheeler’s reform initiative in 2014. It would suit RB insiders to keep debate very limited, and stay as close to the status quo as possible.

      I’ve never argued that reforming governance will produce consistently better monetary policy outcomes, altho it should lift performance a bit on average. The key consideration to my mind is really about legitimacy and serious accountabilty, as well as given a nudge to alter the mindset of the RB mgmt (and clear away the redundant existing board.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s