My dissertation, entitled “The Politics of Monetary Delegation and Central Bank Independence,” is a book-length project in which I present theoretical and empirical evidence challenging the widespread consensus about the benefits of monetary delegation to an independent central bank. Despite their near universal adoption in today’s developed economies, independent central banks are a relatively new institutional phenomenon which only gained global popularity in the 1980s. This rapid and widespread institutional adoption is in part due to a clear and intuitively appealing theoretical argument for its benefits. According to canonical theories, tying the government’s hands and insulating monetary policy from political pressure prevents the government from inevitably pursuing output stimulating, high-inflation policies believed detrimental to sustainable economic growth.
In the theory chapter of my dissertation, I demonstrate this central claim in the extant literature is conditional on a pair of often implicit, empirically indefensible assumptions about the policymaking environment. First, the existing literature with few exceptions assumes the central bank can perfectly determine the inflation rate with their manipulations of monetary policy instruments (i.e., interest rates). Second, for reasons of mathematical convenience, central bank preferences over inflation are typically specified as being perfectly symmetric about an ideal point, meaning deviations of equal magnitude above and below their ideal point are considered equally costly. Taken together, these assumptions about the nature of monetary policymaking force a mathematical property of decision-making known as certainty equivalence, causing monetary policymakers in our models to behave as if they face no uncertainty. Relaxing both assumptions in a formal model of monetary policymaking and central bank appointments, I derive the central result of my dissertation: in volatile economic environments in which the central bank faces high levels of uncertainty over future inflation, the government will appoint more inflation-tolerant central bankers, and vice versa. That is, in precisely the economic climates in which we might expect monetary conservatism and cautious policymakers to be most desirable, politicians are incentivized to staff policymaking committees with inflation-tolerant and risk acceptant policymakers. I go on to show that this has real policy implications: in empirically plausible environments, we ought to observe an even greater high-inflation bias than we would expect had the government maintained policy discretion.
This result is borne out in the data. I draw on a novel dataset and measures of monetary policymaking uncertainty and individual central banker preferences to test these implications empirically on a sample of four countries: Hungary, England, Sweden, and the United States. First, I quantify the central banks’ monetary policymaking and inflation uncertainty by measuring their self-reported forecast uncertainty. This data source and measurement technique are an improvement on many previous measures of central bank uncertainty which provide weaker proxies of the policymaking environment and stand to confound inference in many applications. Second, I employ a Bayesian random coefficient model to estimate both central bankers’ ideal points and the degree of asymmetry in their preferences over inflation. In doing so, I provide the first individual-level estimates of central bank preferences which allow for and quantify preference asymmetries. Notably, thus far in a sample of 61 central bankers, every central banker has asymmetric preferences over inflation which are statistically distinguishable from symmetric. Finally, armed with these estimates I am able to show more inflation tolerant central bankers are appointed in expectation of greater monetary uncertainty. Further, this appointment strategy results in monetary policy committees which in what I show are empirically plausible environments will pursue even more inflation-seeking policies than the government would themselves.
The theoretical and empirical results of my dissertation raise issues with what is arguably the core finding in the literature on monetary policymaking and the institutional design of central banks. When monetary policymaking uncertainty and preference asymmetries are accounted for both theoretically and empirically, delegation to an independent central bank no longer unequivocally improves the government’s ability to achieve their desired economic outcomes. Not only is the canonical result of improved inflation performance under an independent central bank more conditional than suggested in the existing literature, we can under empirically realistic conditions expect outcomes worse than we would observe in the absence of delegation.