A new research report calls for longer terms of office for members of the Bank of England’s
Monetary Policy Committee (MPC). Writing in the January 2006 issue of the Economic
Journal, Brian Henry, Mathan Satchi and David Vines argue that this would guard
against the potential danger of the MPC taking too short-term a view of the economy when
setting interest rates.
Much attention has been given in the press as to whether new MPC appointments are
‘doves’ or ‘hawks’. But past work by Charles Bean – now the Bank’s chief economist but
then an LSE professor – implied that, providing the Bank remains properly independent, we
should not really worry. Both hawks and doves will normally make roughly the same
decision and both are likely to serve society well.
The new study by Professor Vines and colleagues shows that this conclusion is only valid if
policy-makers take a long-term view of the economy. Policy-makers who take a short-term
view are much more likely to disagree and may not serve society well.
We know that the MPC cares about keeping inflation stable, but how much should it also
care about stabilising unemployment? The Bank’s remit does not pin this down with any
precision nor is it clear how it could. So how much the MPC cares about unemployment
must depend largely on the preferences of its individual members. These preferences in
large part determine the differences between doves and hawks.
The issue is this. When inflation rises above target, there is a real trade-off between the
objectives of controlling inflation and controlling unemployment. How much unemployment
is needed to get inflation down again? How can we know how the MPC will respond in such
a situation given that we do not know how much it cares about unemployment? And will it
respond in a way that is in the best interests of society?
Bean’s work suggests that our lack of knowledge is not a problem. This is because policymakers
with quite different ideas on the trade-off will actually choose fairly similar policies.
The reason is that to get inflation down means restraining demand, with the regrettable
consequence of unemployment.
If policy-makers – whether hawks or doves – take a long-term view then, Bean shows, they
will agree among themselves as to how this trade-off should be managed. So long as their
preferences fall into a broad range that can be described as ‘reasonable,’ the outcomes of
policy are not likely to be much altered as policy-makers come and go. And these outcomes
are likely to be similar to the policy of an ‘ideal’ policy-maker, one who cares about inflationunemployment
trade-off in exactly the right way.
The new study shows that this happy conclusion will not hold if policy-makers focus on the
short-term outcomes of policy, rather than taking a long-term view. The reasons are subtle.
Doves who take a short-term view will be likely to want less unemployment after an inflation
shock, and to prefer a policy that would take longer to get inflation down. They would like to
put off the necessary unemployment until the future, when – as viewed from the present – it
will seem less costly. They want to have a good time now rather than high unemployment
now, which would deliver low inflation in the future.
But paradoxically, hawks with short-term view are likely to want to do exactly the opposite.
It may be possible to get inflation down very fast by having high unemployment now. This
will be especially true if tight monetary policy now can cause exchange rate appreciation
and enable lower inflation to be ‘imported’ through cheaper import prices. Impatient hawks
might be prepared to do this now, and then to deal with any problems caused by unwinding
the currency appreciation in the future, when – as viewed from the present – these
problems will seem less costly. They too will want to have a good time now and that means
getting inflation down now, without worrying about the future consequences.
We can thus see that there will be a problem if MPC members take a short-term view: the
views of hawks and doves may come to differ significantly from each other, and from the
‘ideal’ policy. In becoming more short-termist, the hawks and the doves will come to
disagree much more strongly among themselves, and their desired policies may differ very
significantly from ‘ideal’ policy.
Professor David Vines comments:
‘It is important to stress that there is nothing in our work to suggest that members of
the MPC have in fact taken a short-term view. Indeed, the widely perceived success
of the MPC process would actually suggest otherwise.’
‘But we believe that institutional arrangements that deter short-termism from arising
in the future could be very worthwhile. For example, the term of service for a
member of the MPC is currently only three years. This term is unlikely to safeguard
against short-termism: it implies that the average MPC member has a remaining
term of only 18 months. Our suggestion is that the terms of appointment to the MPC
should be lengthened.’
ENDS
Notes for editors: ‘The Effect of Discounting on Policy Choices in Inflation Targeting
Regimes’ by Brian Henry, Mathan Satchi and David Vines is published in the January 2006
issue of the Economic Journal. The authors are at the University of Oxford.
For further information: contact David Vines 01865-271067 (sec: Ann Gibson on 01865-
271090; email: david.vines@economics.ox.ac.uk) or RES Media Consultant Romesh
Vaitilingam on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com).