Toshiro Muto: How do central banks make decisions? - monetary policy
by committee
Summary of a speech by Mr Toshiro Muto, Deputy Governor of the Bank of Japan, at the
Spring Meeting of the Japan Society of Monetary Economics, Chiba, 12 May 2007.
* * *
Introduction
I am honored to have this opportunity to address a society with such a long-standing
tradition. Today, I would like to elaborate on central banks' decisionmaking process,
especially that by committee. Although policy changes by the Bank of Japan attract a lot of
attention, I believe that the decisionmaking process, in which policy is decided by a majority
Results of
vote of the Policy Board, is not widely understood. For example, according to the
the 23rd Opinion Survey on the General Public's Views and Behavior conducted by the Bank
in June 2005, over half of the respondents answered that they had never heard that
"monetary policy aimed at maintaining price stability is conducted based on decisions made
at the Bank's Monetary Policy Meetings."
The Bank has adopted a committee structure in which decisions are made by a majority vote
of the members of the Policy Board. Based on the Bank of Japan Law, which was revised in
1997 and came into effect in April 1998, the Policy Board - the highest decisionmaking body
of the Bank - decides on a wide range of matters, not only those related to monetary policy
but also those related to financial stability and the payment and settlement system. Policy
Board meetings where monetary policy is deliberated and decided are called Monetary
Policy Meetings (MPMs).
Many other central banks have also adopted a committee structure in making monetary
policy decisions, such as the Federal Open Market Committee (FOMC) of the Federal
Reserve System for the United States, the Governing Council of the European Central Bank
(ECB) for the euro area, and the Monetary Policy Committee (MPC) of the Bank of England
(BOE) for the United Kingdom.
I. The quiet revolution: decisionmaking by committee
A. Overview
One of the issues in which academic researchers have shown an increasing interest in
recent years is monetary policy decisionmaking by committee. Professor Alan Blinder at
Princeton University, a former Vice Chairman of the Board of Governors of the Federal
Reserve System during Chairman Greenspan's era, has highlighted a "quiet revolution" in
central banking practice in the past decade: namely, changes in the areas of decisionmaking
by committee, transparency, and communication with the market.1
Decisionmaking by committee requires deliberations among committee members and
collective decisionmaking. The committee structure is not necessarily unique to central
banking. For example, in Japan, the Diet has standing and special committees, and the
government also has independent committees such as the Fair Trade Commission.
Furthermore, some corporations have adopted a committee structure.
Is decisionmaking by committee superior to that by an individual? Intuitively, in line with the
saying "two heads are better than one," groups might come up with better ideas than an
individual. It seems to me that deliberations among multiple individual members with
expertise and diverse insights should lead to a better policy outcome. In other words, through
deliberations members can share their knowledge and skills and correct each other's
misunderstandings, and the shortcomings of individual decisionmaking such as one-sided or
prejudiced views, a lack of multifaceted consideration, and dogmatic attitudes can be greatly
reduced.
Professor Stephen Bainbridge of the UCLA School of Law has studied collective
decisionmaking by the boards of directors of U.S. corporations.2 He refers to the issue of
"bounded rationality" as one explanation of why decisionmaking by group is advantageous
and argues the following:
"Decisionmaking requires the use of scarce resources for four purposes: (1)
observation, or the gathering of information; (2) memory, or the storage of
information; (3) computation, or the manipulation of information; and (4)
communication, or the transmission of information . . . If groups have an
advantage relevant to the institution of the board of directors, it therefore
seems most likely to arise with respect to either memory and/or
computation . . . Put another way, group decisionmaking may be an
adaptive response to bounded rationality, creating a system for aggregating
the inputs of multiple individuals with differing knowledge, interests, and
skills."
B. Research on central banks' decisionmaking by committee
Next, I would like to refer to some of the literature that specifically analyzes central banking
and monetary policy decisionmaking by committee.3
Professor Blinder discusses whether monetary policy should be made by an individual or a
committee and explains why the central banks of many countries have now adopted
committee decisionmaking as follows:4
"I believe that the main factor underlying the worldwide trend toward
monetary policy committees . . . was the perceived success of the Federal
Reserve and the Bundesbank, both of which had long made decisions . . .
by committee. Imitation is, after all, the sincerest form of flattery. In addition,
there is no reason to have a monetary policy committee when the central
bank is simply taking orders from its government. So the trend toward
central bank independence opened the door to committee decisionmaking."
In addition, Professor Blinder summarizes the main arguments for preferring committee to
individual decisionmaking under the following four points,5 which seem to be consistent with
the study on the boards of directors of U.S. corporations that I have just referred to.
1. "Pooling: A committee pools the disparate knowledge of its individual members.
2. Diversity: Members of a committee bring different decisionmaking heuristics to a
complex problem.
3. Checks and balances: Committees are less likely to adopt extreme or idiosyncratic
positions.
4. Reduced volatility: Owing to "averaging" (which need not be interpreted literally), the
decisions of a group are likely to be less volatile."
With regard to the fourth point, however, Professor Blinder argues that it "might conceivably
be turned around and viewed as a vice instead because one person's low volatility is
another's excessive inertia."
Professor Anne Sibert of the University of London notes free riding and group polarization as
possible shortcomings of group decisionmaking.6 With regard to the first issue, she points
out that the free-riding problem can occur, for example, in gathering information and that
larger committees are more likely to encounter this problem than smaller committees.
However, I do not believe that the free-riding problem is likely to emerge in decisionmaking in
committees based on my experience at the Bank, where each member participates in the
decisionmaking autonomously and independently.
With regard to the issue of group polarization, biased group membership and heated
deliberations make the views of individual members less moderate or more extreme. Group
polarization can be inconsistent with excessive inertia, which is noted by Professor Blinder.
Professor Sibert also says that it is debatable whether moderation or polarization is a good
thing. In my experience, group polarization is unlikely to occur if members of the committee
have profound experience and diversified backgrounds.
Summarizing what I have referred to and mentioned so far, the committee structure can be a
better framework for decisionmaking because of the pooling of knowledge, the diversity of
views, and the checks and balances it provides, and such group decisionmaking can be
superior to individual decisionmaking. However, it should be noted that in practice, group
decisionmaking can be excessively inert and the adoption of the committee structure does
not necessarily guarantee the right outcome.
II. The committee's structure of the FOMC, the Governing Council, and the MPC
I will briefly explain how other central banks reach their decisions under the committee
structure. I would like to discuss the FOMC of the Federal Reserve System, the Governing
Council of the ECB, and the MPC of the BOE.
A. The FOMC
The FOMC consists of twelve members: seven members of the Board of Governors of the
Federal Reserve System, including the Chairman and the Vice Chairman, and five Reserve
Bank presidents, of whom four serve on a rotating basis. The other seven presidents also
attend FOMC meetings and participate in the discussions, although they do not have the
right to vote.
Members of the Board of Governors are nominated by the President of the United States and
confirmed by the Senate. In making appointments, the President needs to pay due regard to
a fair representation of financial, agricultural, industrial, and commercial interests, and the
geographical division of the country. On the other hand, the president of each Reserve Bank
is nominated by its board of directors. The nomination process is such that members of the
FOMC would have diversified knowledge and insights. In fact, current members have diverse
career backgrounds as, for example, academics, executives of financial institutions,
highranking officials of international organizations, government officials, and central bankers.
With regard to terms of office, members of the Board of Governors have full terms of 14
years and Reserve Bank presidents have five years.
Transcripts of FOMC meetings reveal that members present various opinions, hold lively
discussions, and make decisions by majority vote. Mr. Meyer, a former member of the Board
of Governors during Chairman Greenspan's era, noted that there were two traditions at the
FOMC: the first was that the Chairman was always expected to be on the winning side of a
policy vote, and the second was that the FOMC strove to reach a consensus on the policy
decision.7 However, votes have not always been unanimous and one or two dissenting votes
are not unusual. In fact, during the second half of 2006, Mr. Lacker, the president of Federal
Reserve Bank of Richmond, dissented because he believed that further policy tightening was
needed.
B. The Governing Council
The Governing Council of the ECB consists of 19 members: six members of the Executive
Board, including the President and the Vice President, and the governors of 13 national
central banks in the euro area. The number of euro area countries has increased from twelve
to 13 with Slovenia joining at the beginning of 2007. Members of the Executive Board are
appointed - from among persons of recognized standing and professional experience in
monetary or banking matters - by the European Council, following necessary procedures.
The governors of national central banks are appointed in accordance with national laws.
The 19 members of the Governing Council, with diverse nationalities, have a wide variety of
career backgrounds, including as academics, executives of financial institutions, politicians,
government officials, and central bankers. Accordingly, reflecting historical and institutional
factors unique to Europe, the Governing Council is a group of experts with diversity, selected
in consideration of expertise and geographical factors. Members of the Executive Board of
the ECB have eight-year terms, and the governors of national central banks, depending upon
national laws, have terms of five years or more.
It is often said that the consensus of the Governing Council in decisionmaking is respected
and that its decision is the result of collective deliberation and debate.8
C. The MPC
The MPC consists of nine members: five internal members, that is, the Governor, the two
Deputy Governors, the Bank's Chief Economist, and the Executive Director for Markets (the
latter two are appointed by the Governor upon consultation with the Chancellor of the
Exchequer), as well as four external members appointed directly by the Chancellor of the
Exchequer. External members are not necessarily full time, and, for example, some
members are concurrently faculty members at universities. Current members have diverse
backgrounds, including as academics, government officials, private-sector economists, and
central bankers. The Governor and the Deputy Governors have five-year terms, and the
others have three-year terms.
At MPC meetings, dissenting votes are cast rather frequently. Sometimes there are four
dissenting votes out of nine. For example, at the January 2007 meeting, the MPC decided to
raise the policy interest rate by a 5-4 majority vote. Governor King was in the majority while
Deputy Governor Lomax and Messrs. Bean and Tucker were in the minority. Votes among
external members were three in favor of the raise and one against, and among internal
members, two were in favor and three against. Moreover, at the August 2005 meeting, the
MPC decided to reduce the policy interest rate by a 5-4 majority vote, and this time,
Governor King was in the minority. All four votes of external members were in favor of the
reduction while votes among internal members were split: one in favor of the reduction and
four against. Interestingly, Governor King later testified before the Treasury Committee of the
House of Commons on November 24, 2005, saying as follows:
"[T]he decision falls out by majority vote . . . it logically follows, as night
follows day, that there will be some times when each and every member of
the Committee may find themselves in a minority, including the Governor,
and I was in that position . . . I felt comfortable about that . . . We believe
that the right thing is that at the end everyone says what they honestly
believe is the right thing to do."
The FOMC of the Federal Reserve System, the General Council of the ECB, the MPC of the
BOE, and the Policy Board of the Bank of Japan have all adopted the committee structure,
but the design and implementation of the committee structure of each of these differ, partly
due to political and historical factors. Each central bank has been making various efforts to
improve its implementation to the extent possible.
III. The framework and procedures of MPMs
Next, I would like to turn to the case of the Bank of Japan and explain the framework and
procedures of MPMs.9
A. The framework of MPMs
Monetary policy is deliberated and decided by the Policy Board at MPMs. The Policy Board
is composed of nine members: the Governor, the two Deputy Governors including myself,
and six other members. Members are all appointed by the Cabinet and approved by the Diet
and serve for five-year terms. Under the old Bank of Japan Law of 1942, the Policy Board
consisted of a total of seven members: the Governor, four appointed representatives with
outstanding experience in the fields of finance, commerce and industry, and agriculture, and
two government representatives without the right to vote. The Bank of Japan Law of 1997
stipulates that the six members other than the Governor and the two Deputy Governors be
appointed from "among those with academic expertise or experience including experts on the
economy or finance." Indeed, Policy Board members come from quite diverse backgrounds
and include former academics, executives of corporations as well as financial institutions,
and private-sector economists.
The number of members of the Bank's Policy Board is nine, which is the same as that of the
MPC of the BOE, but it is smaller than the FOMC of the Federal Reserve System and the
Governing Council of the ECB. According to a survey on central bank laws conducted by the
staff of the International Monetary Fund (IMF), most central bank committees have seven to
nine members.10 If the size of a committee is too small, the accumulation of knowledge
becomes difficult, there is less diversity in perceptions and opinions, and checks and
balances may not function well. On the other hand, if the size is too big, discussions become
less productive. For extensive and constructive discussions where Policy Board members
are given sufficient time to express their views, I believe the current size of nine members is
within the appropriate range for a committee.
At MPMs, the Governor and the Deputy Governors independently express their assessment
on the economic and financial situation and their views on the conduct of monetary policy.
The Governor and the Deputy Governors are also responsible for carrying out decisions of
the Policy Board, together with the Executive Directors and the staff. The six other Policy
Board members are full-time executives. In addition to MPMs, they attend Policy Board
meetings that make decisions, with the Governor and the Deputy Governors, on important
policy issues, such as those on financial stability, business operations, and management
strategy. Given that they hold important positions that require neutrality, they are prohibited
from taking another occupation, and restrictions are also placed on the types of financial
assets they can hold and the financial transactions they can make, as in the case of the
Governor and the Deputy Governors.
MPMs, where the Policy Board decides a guideline for money market operations for the
intermeeting period ahead and formulates the Bank's view on recent economic and financial
developments, are held regularly, once or twice a month. Aside from these meetings, Policy
Board meetings where the Bank's business operations, management strategy, and other
issues are decided are, as a general rule, held twice a week.
B. Preparations for MPMs
Let me describe how Policy Board members prepare for MPMs. Policy Board members
accumulate various types of information useful for the Bank's conduct of monetary policy
through their analysis of the economic situation and financial market developments, the daily
conduct of business operations, and exchanges of views with representatives from various
fields. Utilizing such information as well as knowledge, Policy Board members monitor
carefully economic and financial developments.
The details of the preparation for MPMs are as follows. At least two business days prior to
the MPM concerned, Policy Board members are provided with written reports prepared by
the Bank's staff, which the Bank's staff later use at the beginning of the meeting to present
an assessment of the current economic and financial situation. The reports include a
comprehensive analysis of the economy based on available macro and micro economic
information. In preparation for the MPM, members read through the staff's reports and
formulate their views on the economic and financial situation, the outlook, and the
appropriate direction of monetary policy.
C. Deliberations on the day of the MPM
I will now outline a typical two-day MPM. The first day of the MPM usually starts at 2:00 p.m.
The meeting is attended by Policy Board members and by government representatives,
namely, the Minister of Finance and the Minister of State for Economic and Fiscal Policy or
their designated delegates. Executive Directors of the Bank in charge of departments directly
concerned with monetary policy, and Directors-General and other senior officials of
departments concerned, attend MPMs to report. Others present at the MPM include staff of
the MPM secretariat supporting the proceedings of MPMs. The chairman of the Policy Board
is elected by the Board members from among themselves. The Governor has so far always
been the chairman.
On the first day of the MPM, the staff present reports on recent economic and financial
developments. Specifically, the staff report developments including the results of the Bank's
money market operations and developments in the economy and financial markets in Japan
as well as those abroad. The meeting then moves on to a question-and-answer session
between Policy Board members and the reporting staff.
The second day of the MPM usually starts at 9:00 a.m. The meeting begins with a discussion
among Policy Board members on economic and financial developments. First, each Policy
Board member in turn expresses his or her views on recent economic and financial
developments and the prospects for the future, taking into account the reports presented by
the Bank's staff on the previous day and other members' views. After all the members have
had their turn, discussion starts and members freely and actively exchange views on
economic and financial developments.
Following the discussion on economic and financial developments, Policy Board members
next discuss the conduct of monetary policy. Again, each Policy Board member in turn
expresses his or her views, mainly on whether the Bank should maintain or change the
guideline for money market operations for the intermeeting period ahead, and the reasons.
Furthermore, Policy Board members deliberate on the Bank's conduct of monetary policy in
the longer term. Members then exchange views freely to gain a better understanding of each
other's views and differences in their views, and proceed further with the discussion. In the
course of the discussion, government representatives have an opportunity to make remarks.
D. Votes on policy decisions at MPMs
After the thorough discussions, Policy Board members take a vote on the policy proposal
relating to the guideline for money market operations for the intermeeting period ahead, i.e.,
whether the Bank should change or maintain the guideline for money market operations.
Based on the intensive discussions among Policy Board members at the MPM, the chairman
formulates and submits a policy proposal that reflects the majority view of the members. As I
mentioned earlier, sometimes other Policy Board members who hold different views submit a
proposal separately. The decision is made by a majority vote. This is the process of how the
guideline for money market operations for the intermeeting period ahead and the release of
public statements, which is also put to the vote, are decided.
After the guideline for money market operations for the intermeeting period ahead is decided,
Policy Board members discuss "The Bank's View" of recent economic and financial
developments as well as the outlook, which is published in the Monthly Report of Recent
Economic and Financial Developments. The draft of "The Bank's View" is formulated based
on the members' discussion and put to the vote.
Looking back at past MPMs, votes have not always been unanimous. Since my inauguration
as Deputy Governor in March 2003, I have attended 63 MPMs up to this April. Among these,
the number of MPMs where votes were cast against the chairman's policy proposal on the
guideline for money market operations was as follows: two MPMs with three dissents, 15
MPMs with two dissents, and five MPMs with a single dissent. Moreover, there were 24
proposals other than the chairman's on the guideline for money market operations: at seven
MPMs there were two proposals other than the chairman's, while at ten, there was one
proposal other than the chairman's. There were five MPMs where dissents were cast against
the chairman's proposal without the submission of any other proposal. The fact that votes at
MPMs have not always been unanimous suggests that the autonomy of each Policy Board
member has been respected.
E. Announcement of decisions
After going through the above decisionmaking process, the MPM finally comes to a close.
Policy Board members are provided with sufficient time to hold extensive discussions and the
decisions made at MPMs are announced so that Japanese financial markets can as much as
possible digest the decisions on the day of the meeting. The guideline for money market
operations decided at the MPM is announced immediately after it ends, and the Governor
holds a press conference on that day, usually from 3:30 p.m. To avoid confusion in financial
markets, Policy Board members have agreed to comply with the so-called blackout rule,
which sets a period starting from two business days before an MPM and lasting until the end
of the Governor's press conference. During this period, members must, as a general rule,
refrain from making public comments on monetary policy and economic and financial
developments.
IV. Decisionmaking by committee and central bank independence
Next, I would like to turn to the relationship between decisionmaking by committee and
central bank independence. As previously noted, Professor Blinder makes the interesting
point that "[w]hen the central bank was just following orders communicated by the
government, there was not much reason to have a committee . . ."11 However, a committee
structure is not a necessary and sufficient condition for a central bank to maintain its
independence from the government. More important is the concrete relationship between the
central bank and the government. I will not go into central bank independence in depth today,
but will elaborate on the following points in relation to the committee structure: the
significance of independence for the Bank of Japan; the guarantee of the status of Policy
Board members; and the attendance of government representatives at MPMs.
First, the Bank's independence regarding the conduct of monetary policy, which is referred to
as "autonomy" in the Bank of Japan Law of 1997, has been strengthened since 1998, when
the Law came into effect. Although the Bank remains to a certain degree under the
government's control as a public organization, it is granted by the Bank of Japan Law the
explicit mission to conduct monetary policy in pursuit of price stability, and thus the Policy
Board can make monetary policy decisions independently without external interference.
Second, in order to ensure the independence of the Bank, Policy Board members' term of
office is set as five years and during this term their status is guaranteed, with causes for
dismissal limited to, for example, physical or mental disorders.
Third, the attendance of government representatives at monetary policy committees varies
according to central banks. At the Federal Reserve System, government representatives are
not allowed to attend FOMC meetings. At the ECB, the President of the ECOFIN Council and
a member of the European Commission (usually the Commissioner responsible for
Economic and Monetary Affairs) often attend the Governing Council meetings. At the BOE, a
representative from the Treasury attends MPC meetings.
As for the Bank of Japan, government representatives attend MPMs, as in the case of the
ECB and the BOE. The Minister of Finance and the Minister of State for Economic and Fiscal
Policy or their designated delegates attend MPMs, as specified in the Bank of Japan Law.
They express their views on the state of the economy, the government's conduct of
economic policy, and the Bank's conduct of monetary policy. Although the government
representatives do not have the right to vote, they can submit a proposal requesting to
postpone the Policy Board members' vote on policy proposals to the next MPM. Such a
proposal was in fact presented at the MPM in August 2000. Moreover, government
representatives can submit a proposal for monetary policy measures to be decided by the
Policy Board. In both cases, it is up to the Policy Board to decide whether to adopt any
proposal submitted by government representatives.
In short, the Bank of Japan Law sets forth a transparent framework to facilitate the exchange
of views between the Bank and the government and to ensure the opportunity for the
government to express its opinion concerning monetary policy at MPMs, thereby ensuring
both central bank independence and consistency between the Bank's monetary policy and
the government's economic policy.
V. Decisionmaking by committee and central bank transparency
Next, I would like to turn to the relationship between decisionmaking by committee and
central bank transparency. I will start by describing the communication frameworks regarding
policy decisions at the FOMC of the Federal Reserve System, the Governing Council of the
ECB, the MPC of the BOE, and the Policy Board of the Bank of Japan.
A. Transparency of monetary policy decisions
The FOMC releases a statement concerning the decision made at the meeting on the same
day. The statement contains the Committee's basic view of the U.S. economy, the
Committee's decision regarding monetary policy, and the result of members' vote on FOMC
monetary policy action. The minutes of FOMC meetings are released three weeks after the
date of the policy decision, and transcripts of meetings are released with a five-year lag.
The Governing Council does not release its minutes, transcripts, or details of members'
votes. After the Governing Council meeting, the President, assisted by the Vice-President,
holds a press conference. The President makes an introductory statement, explaining the
decision as well as the economic and monetary analysis, and this is then followed by a
question-and-answer session.
The MPC announces its interest rate decision immediately following the MPC meeting. The
minutes of the MPC meetings are published two weeks after the interest rate decision. The
record of the votes of the individual members of the Committee is released in the minutes.
As for the Bank of Japan, the Policy Board announces, immediately after the MPM, the
decision on its guideline for money market operations for the intermeeting period ahead.
Since the MPM in February 2007, the record of the votes of the individual Policy Board
members has also been released in the announcement of MPM decisions. Shortly afterward
on the same day, the Bank publishes "The Bank's View" in the Monthly Report of Recent
Economic and Financial Developments, and the Governor holds a press conference. The
minutes of MPMs are released around one month after the meeting concerned, and the
transcripts of MPMs are to be published ten years later. The Bank also releases the Outlook
for Economic Activity and Prices semiannually (the April 2007 issue was released recently).
In addition, the Governor reports to and attends the Diet, and Policy Board members
frequently give speeches and accept interviews.
B. Central bank communication with the market
Another important issue is how central banks adopting the committee structure should
communicate with the market. Given that the effects of monetary policy are transmitted via
financial markets, enhancing transparency not only ensures the central bank's accountability
to the public but also improves the effectiveness of monetary policy. However, enhancing the
transparency of policy decisionmaking by committee involves difficult issues, unlike the case
of individual decisionmaking where only one individual needs to be accountable for his/her
decisions. Central banks that adopt decisionmaking by committee need to seek ways to
enhance the accountability of the committee as a whole as well as that of each individual
member, including the governor as the chairman. This issue of accountability also relates to
central bank communication with the market and poses a difficult problem.
In 2000, the third year since the establishment of the MPC, the BOE asked the Vice
Chairman of the Board of Governors of the Federal Reserve System, Mr. Kohn, who was
then the Director of the Division of Monetary Affairs, to assess the transparency of the
policymaking process at the MPC. One of Mr. Kohn's assessments was that "the committee
structure greatly complicates transparency; it is far easier to determine and publish the views
of a single person than it is those of a Committee with nine individually accountable
members."12 The response of the MPC was that "this is particularly true of one important
theme which runs through the Report, namely the problem of reconciling individual
accountability of MPC members with the need to present a collective message to the public
that explains the decisions of the Committee."13
To deal with this problem, the ECB has "placed a premium on speaking "with one voice" and
consensus in decisionmaking."14 This reflects the need to conduct a single monetary policy in
the euro area in the unique environment of European integration. A typical example of
speaking "with one voice" is the press conference by the President held shortly after the
monetary policy decision. Mr. Trichet, the President of the ECB, has often emphasized that it
is his role as the captain to speak "with one voice" on behalf of all members of the Governing
Council of the ECB.
On the other hand, with a view to enhancing the transparency of policy decisionmaking
based on the committee structure, the FOMC, the MPC, and the Policy Board of the Bank of
Japan release the results of the votes of individual members, thus indicating the existence of
minority views, and have also