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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Silvio Berlusconi, 08 June 2004


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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


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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


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• This need not be the actual interest rate; abstracting from a possible monetary policy rule, we model


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• This need not be the actual interest rate; abstracting from a possible monetary policy rule, we model

• Rogoff tells us that


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• The interest rate gap is then


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– Rogoff implies

– Additional weight on national variables implies


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– 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


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• Time variations: preference shift in periods xt


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– Preference shift towards growth, away from inflation

– Preference shift towards national variables

– What dominates for national inflation?


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– Preference shift towards growth, away from inflation

– Preference shift towards national variables

– What dominates for national inflation?

• Again: estimated by means of proxy regression


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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


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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


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


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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

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– Economic performance matters: more pressure from low-growth countries

Data, stylized facts: political pressure 0

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01

5

1999q3 2001q3 2003q3 2005q3 2007q3

.high GDP low GDP

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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?

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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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EAt

Ctz

EAtztz yycycbbapp ,,

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21, )()(

Hypo-thesis

Benchmark All commentsNo fixed

effectsOrdered

probitIncidence of

commentsNegative binomial


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***


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

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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

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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

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Time variations, robustness: negative binomial

– Broadly robust to using only calls for lower rates, all comments, country fixed effects, ordered probit model

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Ctztz

EAt

EAt

Ctz

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3,

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4,

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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

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EAt

Czt

CPEAt

EAPEAt

Ctz

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Ptz

EAt

Czt

CPEAt

EAPEAt

Ctz

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EAPPz

actt yyyi ,

,,,

,, )()(

Hypothesis Benchmark


t

EA P,EA>0 0.518***

y tEA P,EA>0 0.437***


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

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• 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

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• 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

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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

1 politics and monetary policy michael ehrmann and marcel fratzscher european central bank...

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