''Conservative'' Central Bankers Mean More Volatile Interest Rates

01 Jul 2005

A new study of the behaviour of the German Bundesbank over 40 years shows that central banks with ''conservative'' majorities – those tightly focused on price stability – are associated with more volatile short-term interest rates. The research by Professors Helge Berger and Ulrich Woitek, published in the July 2005 Economic Journal, also shows that conservative central bankers react more decisively with higher interest rates to changes in inflation, money and output.

The idea that a society with a preference for low and stable inflation has an incentive to delegate monetary policy to a relatively conservative central banker has proved to be a powerful force in shaping real world institutions. In order to control inflation, the European System of Central Banks was deliberately modelled on one of the most independent and conservative central banks, the Bundesbank. The European Central Bank is, if anything, even more inflation-averse and autonomous than its role model.

That conservative central banks have a strong preference for price stability almost goes without saying. What is less clear, however, is whether conservative central banks really differ when it comes to actual monetary policy. Research on the cross-country correlation between central bank independence/conservatism and inflation suggests that a more conservative central bank – given sufficient independence from a less conservative government – is associated with both a lower level and a lower variance of inflation.

But there are doubters. The critique of the consensus view argues that the available evidence is incomplete and insufficient, for example, because of its focus on outcomes instead of policies. The existing empirical evidence also may be insufficient because it is based on measures of central bank characteristics that unsystematically conflate conservatism and independence.

Berger and Woitek''s research focuses on the example of the Bundesbank, using a sample of monthly data covering most of the post-war period during which the central bank had a virtually unchanging degree of independence. The researchers identify conservative and non-conservative regimes in the bank''s policy council by looking at the political background of individual members. This identifying assumption is supported by an analysis of individual voting behaviour during the early Bundesbank years, which shows that conservative nominees are less likely to resist interest rate increases than non-conservative nominees.

The single-country time-series approach used by Berger and Woitek is much better equipped to deal with many of the arguments raised against the traditional cross-country literature. Quite obviously, a single-country approach avoids the necessity of producing reliable measures of central bank characteristics across different countries. An even more important advantage is that it allows a more detailed analysis, especially of the dynamic properties of central bank behaviour. In addition, it makes it much easier to distinguish between central bank independence and conservatism.

''Does Conservatism Matter? A Time-series Approach to Central Bank Behaviour'' by Helge Berger and Ulrich Woitek is published in the July 2005 issue of the Economic Journal. Helge Berger is Professor of Monetary Economics at the Free University Berlin. Ulrich Woitek is Professor at the Institute for Empirical Research in Economics, University of Zurich.

Helge Berger

+49-30-838-54037 | hberger@wiwiss.fu-berlin.de

Ulrich Woitek

+41-1-634-3650 | u.woitek@iew.unizh.ch