politics and monetary policy michael ehrmann marcel fratzscher european central bank comments:...
TRANSCRIPT
Politics and Monetary Policy
Michael EhrmannMarcel Fratzscher
European Central Bank
Comments:
William Roberts ClarkUniversity of Michigan
Summary/Goals
Show that central bankers are “conservative” in the Rogoff sense (more willing to accept reduced growth in
exchange for price stability) Show that ECB is different because it cares
about Euro-Area whereas politicians also care (i.e. respond to) about differential between their country and Euro-Area’s macroeconomic conditions
Strategy
Assume “silence is consent” and the converse:
calls for lower interest rates reveals politicians are less “conservative” than CB
What Politicians want
That is, interest rates are increasing in inflation and output and increases in inflation and growth differentials
The difference between these is the difference between politician’s and CB’s ideal policy
Yes!
Maybe not (if we relax linearity assumption)
The difference may depend on where one is in the business cycle
i*
growth
CB’s reaction function
Politician’s reaction function
IF and interest rate reveals the preferences of the CB AND politicians advocate changes in policy iff they disagree with cb, then
The propensity to complain about interest rates is increasing in difference between CB and Politician’s ideal interest rates:
Increase in EA inf leads to a bigger change in preferred interest rate of CP than the politicians
Increase in EA gwth leads to a smaller change in preferred interest rate of CP than the politicians
Results
Next the authors text whether time varying factors influence politician’s preferences
Allows authors to compare normal times:
With times of exceptional political pressure:
Results
Pre ElectionLow Voting Support
Low Trust inECB
Excessive Deficit
negative growth differential LEFT party
inflationEA b1>0 -0.609 -5.34 -0.372 -0.525 -0.284 -0.775
yEA c1<0 -0.132 -0.151 -0.171 -0.086 -0.169 -0.067
InfDIFF b2 <0 -0.468 -0.435 -0.424 -0.495 -0.258 -0.602
yDIFF c2 <0 -0.087 -0.109 -0.016 -0.069 0.062 -0.034
InfEA * X b3>0 1.132 -0.016 -0.55 -0.094 -0.35 0.018
yEA * X c3<0 -0.332 -0.001 -0.08 -0.518 -0.062 -0.148
InfDiff * X b4 = ? 0.29 -0.005 0.038 0.016 -0.507 0.216
yDIFF * X c4 <0 0.139 0.005 -0.344 -0.175 -0.235 -0.432
X d -1.874 0.035 1.203 1.061 1.553 -0.095
Compare regular vs. acute political pressures
InflationEA Pre ElectionLow Voting Support
Low Trust inECB
Excessive Deficit
negative growth differential LEFT party
WHEN x=-1 -1.568
WHEN X =0 -0.609 -0.372 -0.525 -0.284 -0.775
WHEN X=1 0.523 -0.922 -0.619 -0.634 -0.757
interaction term sig? yes no no no no no
In the absence of political pressures, an increase in inflationEA has no effect on political demands
when political pressures are present,there is little evidence anything changes
GrowthEAWHEN x=-1 0.081
WHEN X =0 -0.132 -0.171 -0.086 -0.169 -0.067
WHEN X=1 -0.464 -0.251 -0.604 -0.231 -0.215
interaction term sig? no no no yes no no
results somewhat mixed
Growth Differential
WHEN x=-1
WHEN X =0 -0.087 -0.016 -0.069 0.062 -0.034
WHEN X=1 0.052 -0.36 -0.244 -0.173 -0.466
interaction term sig? no no yes no yes yes
INFLATION DIFFERENCEWHEN x=-1 -0.818WHEN X =0 -0.468 -0.424 -0.495 -0.258 -0.602WHEN X=1 -0.178 -0.386 -0.479 -0.765 -0.386interaction term sig? yes no no no no no
in the absence of acute political pressures, an increase in the infation differentail leads to a decrease in demands for lower rates
when accute political pressures are present, there is no relation (consistent with indeterminacy of the hypothesis)
What are the effect of acute political pressures?
“There are PE factors that make politicians shift their preferences even more strongly towards growth, and away from price stability
particularly true when:
1) Growth is low
2) Trust is low
3) When left wing is in power
Evidence for these claims can’t be found by looking at d
Three Possible Responses
Exit Accept that there has been a deleterious change in your environment and alter your behavior to optimize in the new environment.
VoiceUse your ‘voice’ (complain, protest, lobby, take direct action) to try and change the environment back to its original condition.
LoyaltyAccept the fact that your environment has changed and make no changes to your behavior.
The Set-Up
Pre-history…Central bank announces an interest policy higher than preferred by politician.
Politicians must decide whether to: Accept interest rate announced by CB and adopt fiscal policies consistent with it (Accomodate)
Accept interest rate and adopt fiscal policies inconsistent with it (Punish)
Apply political pressure in an attempt to get CB to lower interest rates (PP)
Politician’s response depends on expected response of the CB to PP
High Interest Rates, Expansionary Fiscal Policy
?
Punish Accomodate
PP
High Interest Rates, Fiscal Restraint
Politician
State
State’s response depends on its expectation of citizen’s response
Punish Accommodate
BB
Citizen
Low Interest Rates, Moderate
Fiscal PolicyAccomodate
Stand Firm
?
High Interest Rates, Expansionary Fiscal Policy
High Interest Rates, Fiscal Restraint
Exit, Voice, Loyalty Game
CB
Punish Accomodate
PP
Pol
Accomodate
Stand Firm
Pol
Accomodate
Punish
High Interest Rates, Expansionary Fiscal Policy
High Interest Rates, Fiscal Restraint
Low Interest Rates, Moderate
Fiscal Policy
High Interest Rates, Fiscal Restraint
High Interest Rates, Expansionary Fiscal Policy
Turning Outcomes into Payoffs
Outcome Description Politician CB
O1 CB gets preferred monetary policy, Politician “goes nuclear” on fiscal policy
E 1
O2 CB gets preferred monetary policy, Politician accepts implied fiscal policy
0 1+L
O3 CB adopts low interest rate policy preferred by politician, politician adopts moderate fiscal policy
1-C L
O4 CB gets preferred monetary policy; Politician accepts implied fiscal policy but pays cost for using voice
0-C 1+L
O5 CB gets preferred monetary policy; Politician goes nuclear on fiscal policy an pays cost of using voice
E-C 1
Assumption: 1-C> E
Exit, Voice, Loyalty Game With Payoffs
Punish Accomodate
PP
E;1
Citizen
0;1+L
State
Accomodate
Stand Firm
Citizen
Accomodate
Punish
E-C;1
0-C;1+L
1-C;L
Punish, Punish; Ignore
PP, Punish; Accomodate
Accommodate, Accomodate; Stand
Firm
Accomodate, Accomodate; Stand
Firm
Autonomous L<1
Dependent L>1
Credible Exit 1-C>E>0
No Credible Exit E<0
CB
Politician
Summary of Sub-Game Perfect Nash Equilibria
Summary
CB is only willing to back down under two conditions:The pol must have a credible exit threat
The CB must care more about deterring unwanted fiscal policy than it cares about its preferred monetary policy.
An independent central banker never backs down
According to this little model, we learn that there is more to central bank independence than conservativism. Its one thing to WANT an interest rate lower than politicians, its another to want it enough to take whatever the politician is willing to do in response to a low inflation policy
Summary
If voice was going to be effective, why would the CB announce the high interest rate policy in the first place?
It wouldn’t have!! The CB would always do what the politicians want. Under complete information, PP is off the equilibrium path.
Just because you don’t hear politicians using their voice, doesn’t mean that they are not powerful. It may be that the CB is already doing what they want.
Margaret Thatcher “Being powerful is like being a lady. If you have to tell people you are, you aren’t”
Summary
The insight that powerful people never need to use their voice poses a big problem for empirical study of politics.
When power is most potent, it is least likely to be used.
It is hard to know who has power just by looking at the world.
Summary
The model suggests that politicians only use voice when it will be effective.
BUT we often see politicians complaining about interest rates with the CB ignoring them. Why?
Resort to “incomplete information” to explain why politicians use PP to try to convince CB that they are willing to “go nuclear”Maybe politicians do not see protesting as costly. Maybe politicians enjoy the actual use of voice even if they know they will be unsuccessful.
We can change the game to make C < 0 i.e. protesting has negative costs. When this happens, it is easy to show that the politicians always complain about interest rates.
Conclusion
The Exit, Voice, and Loyalty game reveals what politics is and how it works.
Politics is about using power to influence others while trying to avoid being influenced oneself.
“Voice” and “Exit” should be understood metaphorically here.
“Exit” may mean emigration, but it may also mean changing industry, production processes, or political parties.
The actual use of “Voice” might range from a ballot to a bullet.
The effect of Politics on Demands for Lower Interest Rates conditioned on Euro Area Growth and Inflation