Optimal central bank design: benchmarks for the ECB

The paper discusses key elements of optimal central bank design and applies its findings to the Eurosystem. A particular focus is on the size of monetary policy committees, the degree of centralization, and the representation of relative economic size in the voting rights of regional (or sectoral) interests. Broad benchmarks for the optimal design of monetary policy committees are derived, combining relevant theoretical arguments with available empirical evidence. A new indicator compares the mismatch of relative regional economic size and voting rights in the monetary policy committees of the US Fed, the pre-1999 German Bundesbank, and the ECB over time. Based on these benchmarks, there seems to be room to improve the organization of the ECB Governing Board and current plans for reform. --Central bank design,federal central banks,ECB, Eurosystem,ECB reform

Optimal Central Bank Design: Benchmarks for the ECB

The paper discusses key elements of optimal central bank design and applies its findings to the Eurosystem. A particular focus is on the size of monetary policy committees, the degree of centralization, and the representation of relative economic size in the voting rights of regional (or sectoral) interests. Broad benchmarks for the optimal design of monetary policy committees are derived, combining relevant theoretical arguments with available empirical evidence. A new indicator compares the mismatch of relative regional economic size and voting rights in the monetary policy committees of the US Fed, the pre-1999 German Bundesbank, and the ECB over time. Based on these benchmarks, there seems to be room to improve the organization of the ECB Governing Board and current plans for reform.central bank design, federal central banks, ECB, Eurosystem, ECB reform

Factor Price Equalization? The Cointegration Approach Revisited

Factor price equality across countries is an important implication of the Heckscher-Ohlin-Samuelson model of international trade. Although an influential theoretical result, the model has received surprisingly little empirical support. Burgman and Geppert (1993) argue that this might be due to the neglect of the non- stationarity property of the time series under consideration. Using a cointegration approach, they find strong evidence pointing towards a long-run relationship between factor prices in six major industrialized countries. The present paper shows, however, that there is only limited evidence of cointegration once the finite sample bias is taken into account. Moreover, there is only weak evidence of a significant cointegrating relationship when real (rather than nominal) labor cost data are used. There is some indication of long-run co-movements of real factor prices when using the statistically more powerful bivariate tests rather than a multivariate framework.

The employment effects of labor and product markets deregulations and their implications for structural reform

This study explores the effects of market deregulation on employment growth. Empirical analysis of an OECD country panel (1990-2004) suggests that lower levels of product and labor market regulation foster employment growth, including through sizable interaction effects. A theoretical framework is developed for evaluating deregulation strategies in the presence of reform costs. Optimal deregulation takes various forms depending on the deregulation costs and the strength of reform interactions. Compared to the first best, decentralized decision-making can lead to excessive or insufficient deregulation. Securing the first best requires coordinating deregulation activities across sectors and overcoming the partial perspective of decision makers. --Product market regulation,labor market regulation,employment growth,policy coordination,sequencing

How Should Large and Small Countries Be Represented in a Currency Union?

The likely extension of the euro area has triggered a debate on the organization of the ECB, in particular on the apparent mismatch between relative economic size and voting rights in the Council. We present a simple model of optimal representation in a federal central bank addressing this question. Optimal voting weights reflect two opposing forces: the wish to insulate common monetary policy from changing preferences at the national level, and the attempt to avoid an overly active or passive reaction to idiosyncratic national economic shocks. A perfect match between economic size and voting rights is rarely optimal, and neither is the “one country, one vote principle”. Empirically, there are indications that the pattern of over- and under-representation of member countries in the ECB Council might be extreme by the standards of the US Fed and German Bundesbank and not always optimal.Central Bank, Federal Central Bank, Currency Union, optimal representation, voting, ECB

Does money matter for U.S. inflation? Evidence from Bayesian VARs

We use Bayesian estimation techniques to investigate whether money growth Granger-causes inflation in the United States. We test for Granger-causality out-of-sample and find, perhaps surprisingly given recent theoretical arguments, that including money growth in simple VAR models of inflation does systematically improve out-of-sample forecasting accuracy. This holds for a long forecasting sample 1960-2005, as well for more recent subperiods, including the Volcker and Greenspan eras. However, the contribution of money to inflation forecasting accuracy is quantitatively limited and tends to be smaller in recent subperiods, in particular in models that also include information on real GDP growth and interest rates. --Out-of-sample forecasting,granger causality,monetary aggregates,monetary policy,Volcker,Greenspan

One Country, One Vote? Labor Market Structure and Voting Rights in the ECB

The pending enlargement of the European Monetary Union (EMU) has brought to the fore the discussion of the voting right distribution in the European Central Bank (ECB) council. We show that, in a model where labor unions internalize the inflationary consequences of wage setting, deviating from a voting scheme based purely on economic size can be beneficial. Preliminary evidence on unemployment and voting rights in the ECB council seems broadly in line with this idea. We also point to possible policy implications for EMU enlargement and ECB restructuring.monetary policy, wage setting, European Monetary Union, European Central Bank, euro area, ECB reform, EMU enlargement, accession countries

What Determines Fiscal Policy? Evidence from German States

This paper explores the factors behind the time path of real spending and revenue in the West German states from 1975 to 2004. The empirical approach stresses robustness and takes into account a large set of economic and political variables. Our results suggest that common economic factors and, to a smaller degree, state-specific economic developments are important determinants of state fiscal performance. In comparison, the influence of political factors is limited both in statistical and quantitative terms. Finally, there is evidence that addressing governance problems and ensuring flexibility in terms of fiscal strategy are important ingredients for any policy aimed at improving fiscal outcomes at the state level.German Länder, fiscal policy, public spending, public debt, extreme bounds analysis, governance

Does Conservatism Matter? A Time Series Approach to Central Banking

The empirical literature on central banking has found measures of central bank independence/conservatism to be negatively correlated with inflation and inflation variance across countries. But the cross-country approach has been criticised for its focus on policy outcomes instead of policies, and for the unsystematic conflation of the concepts of independence and conservatism. We avoid these shortcomings by estimating a single-country time series model for the German Bundesbank. We find that an increase in central bank conservatism leads to higher short-term interest rates and a more activist stabilisation policy with respect to macroeconomic shocks. More conservative Bundesbank regimes are associated with a less volatile economy, higher output and somewhat lower inflation. We also investigate the interaction between the central bank and the government. It turns out that non-conservative Bundesbank Councils react more strongly to macroeconomic shocks under conservative than under non-conservative government regimes.Central Bank Independence and Conservatism, Monetary Policy, Central Bank Government Relations, Generalised Impulse Responses

Too many cooks? Committees in monetary policy

How many people should decide about monetary policy? In this paper, we take an empirical perspective on this issue, analyzing the relationship between the number of monetary policy decisionmakers and monetary policy outcomes. Using a new data set that characterizes Monetary Policy Committees (MPCs) in more than 30 countries from 1960 through 2000, we find a U-shaped relation between the membership size of MPCs and inflation; our results suggest that the lowest level of inflation is reached at MPCs with about seven to ten members. Similar results are obtained for other measures, such as inflation variability and output growth. We also find that MPC size influences the success of monetary targeting regimes. In contrast, there is no evidence that either turnover rates of MPC members or the membership composition of MPCs affect economic outcomes. --Central bank design,monetary policy committee,central bank board,central bank council,governance,inflation.