Bankers, Bureaucrats, and Central Bank Politics

i i “bbc” — // — : — page v — i i Bankers, Bureaucrats, and Central Bank Politics THE MYTH OF NEUTRALITY ChristopherDo Adolph University of Washington,Not Seattle Distribute PE i i i i i i “bbc” — // — : — page vi — i i Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Mexico City Cambridge University Press Avenue of the Americas, New York, -, www.cambridge.org Information on this title: www.cambridge.org/9781107032613 © Christopher Adolph This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published Printed in the United States of America Grateful acknowledgement is made to the BBC, Antony Jay, and Jonathan Lynn for permission to reproduce selections from Yes Minister, © BBC , . A catalog record for this publication is available from the British Library. Library of Congress Cataloging in Publication data Adolph, Christopher, – Bankers, bureaucrats, and central bank politics : the myth of neutrality / Christopher Adolph. p. cm. – (Cambridge studies in comparative politics) Includes bibliographic references and index. ---- (hardback) . Monetary policy. Banks and banking, Central – Political aspects. Bureaucracy. I. Title. II. Series. ./ – dc ---- Hardback Cambridge University Press has no responsibility for the persistence or accuracy of s for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. PE i i i i i i i “bbc” — // — : — page — i The Dilemma of Discretion If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself. J M, Federalist It’s simple. We own them, we tell them what to do and if the directors don’t, we sack them and get people who can. Swedish Finance Minister A B on nationalized banks* build up a single encompassing theory: we cannot understand the politics of monetary policy – from the selection Tof central bankers and central bank institutions to the creation of short run economic outcomes – unless we understand the objectives of the central bank officials who actually make monetary policy. This theory rests on the in- sight that economic performance results not from institutions or interests alone, but from their interaction across the political economy. The first part of this book laid out a career theory of monetary policy cen- tered on the idea that past experience (career socialization) and the shadow of * Borg pointed out this rather direct career incentive to a British peer, who asked how the Swedish government made their newly nationalized banks increase lending (Lord Oakeshott, quoted in Paul Owen and Andrew Sparrow, “London mayor and local elec- tion results – live coverage,” The Guardian, May , ). PE i i i i i i i “bbc” — // — : — page — i , , the future (career incentives) lead some central bankers to favor tighter monetary policy, and others to take a easier stance. The stereotypical conservative career type is the former private banker and stands in contrast to the dovish former bureaucrat. Using a comprehensive new database of central bankers’ career histories over the last half of the twentieth century, I showed these same career types reprise their roles in different concentrations in central banks across the world, setting the stage for a broadly applicable measure of variation in central banker conservatism. The career approach explains different facets of monetary policy over a wide array of countries: career effects lie behind individual central bankers’ votes and revealed interest rate preferences in the United States, collective interest rate decisions by central bank boards across the rich democracies, and inflation rates around the globe. In a side-by-side comparison, career factors appear at least as important as central bank independence. Moreover, career effects are more robust and portable than central bank independence, explaining behavior in industrialized countries as well as the developing world. The second part of the book expanded the argument to take institutional context into account. Preferences and institutions belong to the same puzzle, and the effect of each depends on the other. Unfortunately, the preferences of policy making agents and the liberty or constraint bestowed on them by institutions are seldom studied jointly, particularly in central banking. Using career- based measures of central banker conservatism, I showed that conservatism and independence reduce inflation most when they coincide, but much less when only one is present. I extended the argument to further institutional interactions and looked at the effects of central bank nonaccommodation under different labor market arrangements and partisan governments. This nuanced approach allows us to sort out the effects of monetary policy on the real economy. When labor union are mostly (but not entirely) self-restraining in their wage demands, aggressive nonaccommodation bears an unemployment cost. But where wage bargaining structure produces excessive real wage pressure, central bank nonaccommodation helps keep a lid on inflation without raising unemployment. Finally, partisan governments play a role: left-wing governments lower unemployment in moderately centralized labor markets, where social policy concessions offer an alternative way to mollify labor unions’ wage demands. Finally, in the third part of the book, I turned from the economic performance of political agents to the politics of economic performance. Because different types of central bankers have different effects on inflation and unem- PE i i i i i i i “bbc” — // — : — page — i : ployment, partisan governments have preferences over the types of agents they appoint. This connection between partisan governments and central bank ap- pointees ties voters’ choices to short-run economic outcomes – central bank independence has weakened the link between elections and monetary policy, but cannot completely sever it. Because every term of office must eventually end, governments have a final chance to hold central bankers accountable through the reappointment process. I find that central bankers are more likely to stay in office when they produce the economic outcomes sought by the party in power. However, the financial sector’s role as a shadow principal offering outside employment may limit government’s ability to hold central bankers to account through reappointment rewards. Monetary Policy and Shadow Principals in the United States and Europe This book’s findings have significant implications for the design of real-world macroeconomic institutions. Consider central bank independence, now em- braced around the world as a simple “solution” for the problem of inflation. Seducing some supporters with a clever idea backed by tantalizing evidence, while providing powerful financial sector actors with an intellectual mandate for the self-regulation they’d always wanted, the proposal of a few academic economists to solve a specific time-inconsistency problem in monetary policy helped create independent central banks around the globe (Maxfield, ; Johnson, ). Like many popular economic memes, reformers’ preference- free version of central bank independence has proven too simple and too catchy, depriving policy makers and publics of the economic imagination needed to solve any crisis other than a rerun of s-style inflation (Stiglitz, ). A broader perspective, still consistent with the foundational theoretical research on the problem of monetary policy delegation, suggests governments should select legally independent central bankers carefully. Governments should bear in mind that central bankers’ preferences determine whether the economy achieves good nominal and real outcomes throughout the business cycle, as well as whether the full force of monetary policy and regulation is brought to bear to prevent and combat financial crises. (And outside of crises: to the extent private banks care even more about day-to-day regulatory decisions than interest rate policy, a book parallel to this one but focused on the effects of financial shadow principals on these choice would likely find even greater policy effects from central banker careers.) PE i i i i i i i “bbc” — // — : — page — i , , Although Chapter found strong partisan effects on central bank appoint- ment, not all governments treat this decision as seriously as they should. Some central bankers are plainly too conservative to be a good fit with the elected governments that appointed them and the mass publics to whom they are re- sponsible. And though the definition of “too conservative” depends on the so- ciety, it surely includes any central banker who fears inflation more than unemployment in the midst of the deepest debt-deflation spiral since the Great Depression. There can be no better sign that independent central banks have lost their way than Kenneth ogoff ’s quixotic efforts to help central bankers understand that not all monetary policy problems demand a hawkish response. Starting in , ogoff began advocating “ percent inflation

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