1 politics and monetary policy michael ehrmann and marcel fratzscher european central bank...
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Politics and Monetary Policy
Michael Ehrmann and Marcel FratzscherEuropean Central Bank
Conference on Central Bank Communication, Decision-Making and Governance
Waterloo, 28/29 April 2009
The usual disclaimers apply.
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“We have continuously asked and asked the European Central Bank to review its rates to reduce the euro-dollar exchange level. If this does not happen, I think we should aim to have a political committee with government representatives to work alongside the central bank”
What the paper is about
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“We have continuously asked and asked the European Central Bank to review its rates to reduce the euro-dollar exchange level. If this does not happen, I think we should aim to have a political committee with government representatives to work alongside the central bank”
Silvio Berlusconi, 08 June 2004
What the paper is about
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“We have continuously asked and asked the European Central Bank to review its rates to reduce the euro-dollar exchange level. If this does not happen, I think we should aim to have a political committee with government representatives to work alongside the central bank”
Silvio Berlusconi, 08 June 2004
Background:
– Exchange rate at 1.15, policy rates at 2%
– European elections on June 13, 2004
– Voting support for Forza Italia had just dropped by 5.8%, from a high of 33% in 2002Q1 to 23% in 2004Q1
– GDP growth, 2004Q1: 0.8% in Italy, 1.7% in euro area
What the paper is about
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• Kydland and Prescott (1977), Barro and Gordon (1983): inflationary bias, time inconsistency if monetary policy run by governments
• Rogoff (1985): appoint a conservative central banker, with greater weight on price stability than government
• Alesina and Tabellini (2007, 2008): socially optimal vs actual delegation of tasks to bureaucrats
– Socially optimal to delegate tasks with time inconsistent preferences
– Actual delegation of tasks that are exposed to risk: shift blame
• Given these incentives, politicians are likely to put pressure on independent central banks, or criticise their actions
Introduction
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• This paper analyses the political controversies for the ECB
– Is the ECB conservative in Rogoff’s sense?
– Additional disagreement due to different constituencies in a monetary union?
– Are politicians’ preferences time varying?
• Database containing politicians’ statements about the ECB’s monetary policy, covering 9 years and heads of governments plus all ministers of 12 countries
Introduction
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• Politicians’ preferred interest rates substantially lower than actual rates
• ECB is conservative in Rogoff’s sense, i.e. politicians would like to put more emphasis on growth
• Bulk of controversies arises due to different constituencies
• Time variations matter: preference shift
– If national economic performance is weak
– If the public has generally little trust in the ECB
– Depending on the affiliation of parties in government
Results
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• Literature review
• A model of politicians’ preferences
• Data, stylized facts
• What weights on price stability and growth?
• Time variations in politicians’ preferences
• Politicians’ desired interest rates
• Conclusions
Overview
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• Normative aspects of delegation of tasks
– Intrinsic motivation differences between politicians and bureaucrats: Dewatripont, Jewitt and Tirole (1999), Maskin and Tirole (2001), Besley and Coate (2003), Schultz (2008)
– Socially optimal to delegate if time inconsistency and short-termism are an issue, or if tasks are technically complex; no delegation in case of uncertainty about social preferences, or if compensation of losers is important (Alesina and Tabellini 2007)
• Positive aspects of delegation of tasks (Alesina and Tabellini 2008; Epstein and O’Halloran 1999)
– Politicians decide on delegation, given their incentive structure
– Delegate risky tasks, attempt to shift blame with adverse outcomes, claim responsibility with positive outcomes
Literature review
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• Empirical literature
– Is the Fed influenced by Congress? Role of monetary policy in political business cycles
• Yes: Alesina and Sachs (1988), Grier (1993), Abrams and Iossifov (2006), Hellerstein 2007)
• No: Wooley (1984), Faust and Irons (1999)
– Measurement of political pressure and its effects
• Havrilesky (1993): number of reports in Wall Street Journal about politicians arguing for more or less restrictive monetary policy; affects actual interest rates
• Maier, Sturm and de Haan (2002): no effect for Bundesbank
• Gersl (2006): no effect for Czech National Bank
• Maier and Bezoen (2004): index for ECB, until 02/2002
Literature review
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• Based on politicians’ statements
– 20 October 2006: “German Economics Minister Michael Glos said Friday that the European Central Bank is in no hurry to raise interest rates from a German perspective, pointing to the country's low inflation rates.” Source: Dow Jones International News
– 01 February 1999: “German Finance Minister Oskar Lafontaine again hinted Monday at the desirability of an ECB rate cut to stimulate growth and employment in the euro-zone.” Source: Market News International
– 27 February 2007: “Austrian Chancellor Alfred Gusenbauer said the European Central Bank (ECB) might have to adapt its interest rate policy to match the current economic situation.” Source: Reuters News
A model of politicians’ preferences
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• Preferred interest rates a function of inflation and growth in the euro area and the national economies
A model of politicians’ preferences
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• Preferred interest rates a function of inflation and growth in the euro area and the national economies
• This need not be the actual interest rate; abstracting from a possible monetary policy rule, we model
A model of politicians’ preferences
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• Preferred interest rates a function of inflation and growth in the euro area and the national economies
• This need not be the actual interest rate; abstracting from a possible monetary policy rule, we model
• Rogoff tells us that
A model of politicians’ preferences
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• The interest rate gap is then
A model of politicians’ preferences
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• The interest rate gap is then
– Rogoff implies
– Additional weight on national variables implies
A model of politicians’ preferences
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17
• The interest rate gap is then
– Rogoff implies
– Additional weight on national variables implies
• Need to run a proxy regression due to unobservability of preferred interest rate
– assume that political pressure is increasing in the gap
A model of politicians’ preferences
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18
• Time variations: preference shift in periods xt
A model of politicians’ preferences
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• Time variations: preference shift in periods xt
– Preference shift towards growth, away from inflation
– Preference shift towards national variables
– What dominates for national inflation?
A model of politicians’ preferences
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• Time variations: preference shift in periods xt
– Preference shift towards growth, away from inflation
– Preference shift towards national variables
– What dominates for national inflation?
• Again: estimated by means of proxy regression
A model of politicians’ preferences
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• Extract politicians’ statements
– Factiva (14,000 sources)
– 1999-2007
– Heads of government, ministers of 12 euro area countries
– Avoid double counting (in contrast to Havrilesky)
• Classify and code politicians’ statements
– Statements about future interest rate decisions and those about mandate, independence, past decisions, exchange rate
– Code as
Data, stylized facts: political pressure
rateshigherforcall
statementneutral
rateslowerforcall
Ct
1
0
1
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• Issues
– Search in English; consistency check with other languages gave few differences (newswires important!)
– Exclusion of local government officials, opposition parties, lobby groups, trade unions, international institutions
– Classification and coding subjective
• Done independently according to content analysis (Holsti 1969)
• Rather plain language, coding comparatively uncontroversial
– An independent role of the media?
• Aggregation into 299 quarterly observations per political party, ranging from -1 to 11
Data, stylized facts: political pressure
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– Strong asymmetry, only 5% of statements calling for higher rates
– Considerable cross-country variation
– National performance seems to matter, e.g. Spain
Data, stylized facts: political pressure
Lower rates Neutral Higher rates Total
Austria 28 2 0 30Belgium 42 4 0 46Spain 22 7 8 37Finland 1 3 0 4France 83 7 0 90Germany 92 8 2 102Greece 4 5 0 9Ireland 2 1 2 5Italy 24 2 1 27Luxembourg 11 8 0 19Netherlands 1 4 3 8Portugal 7 0 0 7
Total 317 51 16 384
Comments on future interest rate decisions
Country
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– Time variations; high pressure in 2001-2003, 2005/2006
– Discussion since French presidential election campaign reflected in comments on mandate
Data, stylized facts: political pressure
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45
inte
rest
rat
e
05
10
15
20
pol
itica
l pre
ssur
e
1999q3 2001q3 2003q3 2005q3 2007q3
.political pressure interest rate
25
– Economic performance matters: more pressure from low-growth countries
Data, stylized facts: political pressure 0
51
01
5
1999q3 2001q3 2003q3 2005q3 2007q3
.high GDP low GDP
26
Data: political economy variables
• Periods when politicians might shift preferences towards growth, or more likely to pressure ECB
– Pre-election period (Drazen 2000); dummy for election quarter
– Low voting support; rate of decline of voting support
– Low public trust in ECB; dummy equal one if share of respondents in Eurobarometer survey mistrusting the ECB is above sample mean
– Excessive deficit procedure; dummy when procedure in place
– Negative growth differential (Alesina and Cukierman 1990, Rogoff and Sibert 1988); dummy if national growth below euro area
– Left-wing party (Hibbs 1977, Powell and Whitten 1993, Swank 1993); dummy based on Chapel Hill Party Dataset 2002
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Hypo-thesis
BenchmarkAll
commentsPre-2007
No fixed effects
Ordered probit
Negative binomial
Euro area macro variables:
t
EA b1>0 -0.526 -0.507 -0.454 -0.373 -0.309 -0.460*
y tEA c1<0 -0.143* -0.099 -0.184** -0.173** -0.151** -0.186***
Country-specific macro differences:
tC
tEA b2<0 -0.444*** -0.512*** -0.248 -0.482*** -0.386*** -0.476***
y tC -y t
EA c2<0 -0.073* -0.105** -0.081 -0.091*** -0.043* -0.161**
Party fixed effects Yes Yes Yes No Yes Yes
Observations 299 299 257 299 299 299
R-squared 0.27 0.28 0.29 0.12 0.14
– Larger desired weight on GDP growth
– Larger desired focus on national economy
– Robust to adding unemployment or the exchange rate
What weights on price stability and growth?
tzEAt
Ctz
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Ctz
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What weights on price stability and growth?
– Larger desired weight on GDP growth
– Larger desired focus on national economy
– Robust to adding unemployment or the exchange rate
tzEAt
Ctz
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Ctz
EAtztz yycycbbapp ,,
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Hypo-thesis
Benchmark All commentsNo fixed
effectsOrdered
probitIncidence of
commentsNegative binomial
Euro area macro variables:
t
EA b1>0 -0.526 -0.507 -0.373 -0.309 -0.157 -0.460*
y tEA c1<0 -0.143* -0.099 -0.173** -0.151** -0.211*** -0.186***
Country-specific macro differences:
tC
tEA b2<0 -0.444*** -0.512*** -0.482*** -0.386*** -0.326* -0.476***
y tC -y t
EA c2<0 -0.073* -0.105** -0.091*** -0.043* -0.023 -0.161**
Party fixed effects Yes Yes No Yes Yes Yes
Observations 299 299 299 299 299 299
R-squared 0.27 0.28 0.12 0.14 0.24
29
Time variations
– Preference shift • If national economy performs poorly
• If the public has generally little trust in the ECB
• Depending on affiliation of parties in government
tztztzEAt
Ctztz
EAt
EAt
Ctz
EAtt
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4,
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Hypo-thesis
Pre-election period
Low voting support
Low public trust in ECB
Excessive deficit
procedure
Negative growth
differential
Left-wing party
Political economy variables & interaction terms:
tEA * x t b3>0 1.132** -0.016 -0.550 -0.094 -0.350 0.018
y tEA * x t c3<0 -0.332 0.001 -0.080 -0.518* -0.062 -0.148
(t
C t
EA ) * x t b4=? 0.290 -0.005 0.038 0.016 -0.507* 0.216
(y tC -y t
EA ) * x t c4<0 0.139** 0.005 -0.344** -0.175 -0.235* -0.432**
x t d = 0 -1.874 0.035 1.203 1.061 1.553 -0.095
Party fixed effects Yes Yes Yes Yes Yes YesObservations 299 299 299 299 299 299R-squared 0.27 0.27 0.30 0.28 0.31 0.35
30
Time variations, robustness: negative binomial
– Broadly robust to using only calls for lower rates, all comments, country fixed effects, ordered probit model
tztztzEAt
Ctztz
EAt
EAt
Ctz
EAtt
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Ctz
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4,
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21,
4,
3,
21, )()()()(
Hypo-thesis
Pre-election period
Low voting support
Low public trust in ECB
Excessive deficit
procedure
Negative growth
differential
Left-wing party
Political economy variables & interaction terms:
tEA * x t b3>0 1.927** 0.007 -0.410 0.310 -0.326 0.016
y tEA * x t c3<0 -0.461* 0.002 0.047 -0.225 0.081 -0.020
(t
C t
EA ) * x t b4=? 0.190 0.005 0.048 0.044 -0.235 0.182
(y tC -y t
EA ) * x t c4<0 0.268* 0.007 -0.307*** 0.025 -0.370* -0.267**
x t d = 0 -3.562* -0.013 0.706 -0.301 1.021 -0.170
Party fixed effects Yes Yes Yes Yes Yes Yes
Observations 299 299 299 299 299 299
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• Extracting politicians’ preferred interest rates
– Assume
– Estimate preferred rate for all neutral speakers
– Use estimated parameters to predict preferred interest rates for the non-neutral speakers (assuming model constancy)
0 tactt
Pt ppifii
Politicians’ desired interest rates
Ptz
EAt
Czt
CPEAt
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32
Politicians’ desired interest rates
Ptz
EAt
Czt
CPEAt
EAPEAt
Ctz
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actt yyyi ,
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Hypothesis Benchmark
Euro area macro variables:
t
EA P,EA>0 0.518***
y tEA P,EA>0 0.437***
Country-specific macro differences:
tC
tEA P,C>0 0.327***
y tC -y t
EA P,C>0 -0.007
Const. 0.759*
Party fixed effects YesObservations 131R-squared 0.610
33
Politicians’ desired interest rates
• Preferred interest rates rise by
– 50 basis points in response to a 1% increase in euro area inflation
– 40 basis points in response to a 1% increase in euro area growth
– 30 basis points in response to a 1% increase in domestic inflation
34
Politicians’ desired interest rates
• Plot for the preferred interest rate of the average politician
– Mostly desire for more accomodation, partially substantial gaps
12
34
5
1999q3 2001q3 2003q3 2005q3 2007q3
.actual impliedpreferred
35
Conclusions
• Politicians’ preferred interest rates substantially lower than actual rates
• ECB puts more emphasis on price stability than politicians, i.e. is a Rogoff-type of central bank
• Lots of controversy arises due to different constituencies
• Time variations in politicians’ preferences
• Independence of ECB important to shield it from
– Time varying demands by politicians
– National concerns of politicians