As the EU prepares to welcome up to twelve new members, debate is heating up among the leading candidate countries about whether or not speedy adoption of the euro will promote or impede rapid catch-up growth. But expanding the reach of monetary union raises two equally fundamental questions for current euro members: does formal political independence for the European Central Bank (ECB) deliver truly independent judgments about policy? If not, will expansion aggravate the problem because the biases of ECB members will become even more divergent than they are today?
Each new entrant into Europe's monetary union adds one member to the ECB's Governing Council, the group that sets the euro area's monetary policy. With 18 members, the Governing Council is already larger than the governing bodies of the US Federal Reserve Board, the Bank of England, or the Bank of Japan. To reduce the risks of unwieldiness, the ECB needs to reform its Governing Council now.
While the Nice Treaty does not permit re-structuring the Governing Council, it does allow for change in the voting rule that the Council uses. A rule that requires a rotation of votes among Council members, or that groups them into voting blocs, could replace the current one-man-one-vote scheme.
How would such a change affect European monetary policy? Enlargement of monetary union will increase the relative number of national central bank chiefs on the Governing Council. Each entrant will add one member, while the number of officials from the ECB's headquarters in Frankfurt will remain fixed at six. Some observers suggest that this shift will make European monetary policy more prone to the regional biases of national central banks.
But it may be a mistake to assume that central bankers in Frankfurt lack regional or national bias. I examined the question of regional bias in the US Federal Reserve, whose monetary policy body, the Federal Open Market Committee (FOMC), is composed of seven officials from Washington and five from regional offices. I analyzed records from 1978 through 2000, which included 214 meetings and conference calls, with more than 2,400 votes by FOMC members.
America's Fed policymakers are more likely to dissent in favor of lower interest rates when their region's unemployment rate is higher than the national average. They are also more likely to dissent in favor of raising rates when their region's unemployment rate is below the national average. So officials in Washington seem to be more, not less, sensitive to regional unemployment than officials in regional Fed offices!
Is the same thing true of the ECB? To find out, an identical analysis of its policy deliberations would be needed, but the absence of recorded and published votes makes this impossible. I devised an experiment that allows us to look at whether national loyalties played a role in ECB policy since the euro's inception.
This experiment assumed that each member of the ECB's Governing Council casts votes on the basis of the difference between his country's inflation rate and the average inflation rate in the euro area during the previous month. It also assumed that if the difference between the national inflation rate and the euro-area average exceeded a certain threshold in the month prior to a monetary policy meeting, the Governing Council member would vote in a particular fashion.
For example, if national inflation were higher than euro-area inflation by more than a particular amount (the threshold value), then a Council member from that country would vote in favor of monetary tightening or against monetary easing. If it were lower than the euro-area average by more than the threshold value, then he or she would vote against monetary tightening or in favor of monetary easing. Finally, I assumed that all policy decisions were made on the basis of a simple majority vote.
I analysed the 11 instances in which the ECB changed interest rates from January 1999 through December last year. Taking into account the national identities of each Governing Council member, I calculated the total number of members who would have voted contrary to the actual monetary policy change that was made, given the assumptions about differences between national and euro-zone inflation rates. I then repeated the experiment using various threshold values.
The results indicate that the ECB's monetary policy decisions are consistent with the regional bias hypothesis. In nearly every case and for every threshold value tested, a majority of Governing Council members voted for the policy change that actually occurred, and their votes could be predicted by the difference between their national inflation rate and the euro-area average.
One proposal for voting reform on the Governing Council gives greater weight to the six policymakers at the ECB's center, under the assumption that these officials are less likely to be swayed by national interests. But my experiment indicates that even when voting is limited to these six officials, the policy decisions taken between January 1999 and December last year are consistent with outcomes based on differences in regional inflation.
Two conclusions follow from all this: first, any change to the voting rules of the ECB's Governing Council should minimize the potential for regional bias, which can only grow with expansion eastward. Second, reformers should not presume that officials at the ECB's Frankfurt headquarters are less likely to show bias than officials from national central banks.
Ellen Meade is senior research fellow for the Centre for Economic Performance at the London School of Economics. Copyright: Project Syndicate
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