Mervyn King: The Monetary Policy Committee - five years on
Speech delivered by Mr Mervyn King, Deputy Governor of the Bank of England, to the Society of
Business Economists, at the Royal College of Pathologists, London, 22 May 2002.
I would especially like to thank Claire Lombardelli, James Proudman and James Talbot for their expert help in
conducting and analysing the experiment reported in this paper. I have also benefited from useful comments from
Charlie Bean, Mark Cornelius, Spencer Dale and Peter Rodgers. Richard Geare provided help with the data.
* * *
Five years ago, the power to set interest rates in this country was given to a new Monetary Policy
Committee (the MPC). That decision is still widely regarded as the most important taken by the
incoming new Labour Government. At the time, the decision to create the MPC was controversial.
That is hardly surprising. Few decisions have as much economic impact as the level of short-term
interest rates. They attract the interest of politicians and the media, yet when the MPC sets interest
rates, it acts independently of government. The government sets the target, but the Committee sets
interest rates to meet that target.
Compared with many other countries central bank independence in the UK is relatively recent,
although not unprecedented. The most famous cartoon of the Bank of England - Gillray's The Old
Lady of Threadneedle Street - shows Pitt, Prime Minister at the time, ravishing an old lady -
personifying the Bank - whose dress is made of one pound notes. The Pitt Government had made
repeated demands on the Bank of England for gold to pay for the wars against France. Eventually, the
fall in the Bank's reserves forced it to suspend convertibility of its notes into gold, and low
denomination notes were issued for the first time. The Gillray cartoon - which appeared in May 1797 -
was the origin of the moniker, the Old Lady of Threadneedle Street. Was it mere coincidence, or divine
retribution, that it was exactly two hundred years later, to the very month, in May 1997, that the Bank
of England regained its independence?
In an age when governments are increasingly held responsible for more and more aspects of our lives,
there are not many examples of major decisions being delegated to a non-political body. The
Monetary Policy Committee has broken new ground in British constitutional history. Only three months
before the MPC was set up, Peter Hennessy described the British system of government as
dependent upon "a handful of inside advisers spinning between them what Phillip Ziegler has called
'instantly invented precedents' from the warp and woof of past constitutional practice and experience".
For much of the past forty years there have been rather too many "instantly invented precedents" in
the conduct of monetary policy. But, very occasionally, a constitutional reform occurs which leads to a
new piece of machinery. That was the case with the MPC.
The Committee itself has an interesting and unusual structure: five executive members of the Bank
and four external non-executive members, all chosen for their expertise on monetary policy and not as
representatives of different interest groups. You may wonder whether the nine members of the MPC
have any historical antecedents. If you look carefully you can see them in one of our few remaining
great Jacobean houses - Aston Hall in Birmingham. In the Great Dining Room there is a frieze, a
marvellous example of early seventeenth century plasterwork, showing a set of nine warriors. These
are known as the "nine worthies", described as "high-relief figures in their own niches separated by
scrolling", a pretty good description of the MPC. The Nine Worthies of Chivalry as they are known,
comprise three groups: three honest heathens, three Old Testament heroes and three champions of
Christendom. It is interesting to speculate into which of these groups various members of the MPC fall,
but I will leave that to you. But, wait a moment, there are two additional figures in the frieze. One is
Perseus - presumably the minute taker. The other is described as a "so-far unidentified figure,
certainly a later pastiche". This must be the Treasury representative. Sadly, the debates among the
nine worthies, presumably recorded in the minutes and reported to Sir Thomas Holte who
commissioned the frieze, are lost to posterity. In contrast, the debates among the MPC are published
in the monthly minutes and are the subject of much commentary in the press.
I want, this evening, to pose four questions about the role and record of the MPC. First, why give the
power to decide interest rates to a committee rather than an individual? Second, does it matter that the
MPC frequently disagrees about its decision? Third, has the Committee communicated clearly the
reasons for its decisions? Fourth, does the MPC require reform?
Let me try to answer those questions in turn.
1. Why give the power to decide interest rates to a committee?
The academic argument for central bank independence is well established, but why delegate
monetary policy to a committee rather than an individual? In many other situations where expertise is
crucial, groups of experts are often regarded as superior to individuals. So one motive could be that
committees make better decisions. The technical nature of the monthly interest rate decision gives a
natural division of responsibilities between a democratically elected government that chooses the
target and an appointed group of experts who set rates to meet that target.
One dissenting voice comes from Sir Alec Issigonis - inventor of the Mini - who once said, 'A camel is
a horse designed by a committee'. Despite this view, there is a wide range of evidence to suggest that
in many other real-world scenarios, a committee is often the preferred decision-making body. Really
important people are treated by teams rather than a single doctor, and when legal decisions reach the
highest level of appeal it is to a panel of judges such as the Law Lords and the Supreme Court, not a
single individual, to whom the case is referred.
Decisions that depend on technical knowledge seem, by revealed preference, to be given to groups
rather than individuals, and setting interest rates by committee is no exception. A wide-ranging survey
undertaken by the Centre for Central Banking Studies at the Bank of England found that 79 central
banks out of a sample of 88 use some form of committee structure when setting monetary policy.1 But
there is, by its very nature, rather little empirical evidence on the relative merits of decision-making by
individuals versus groups. And, even if one accepts that some decisions should be delegated to
technical experts, what is the best way to weight together the opinions of those experts?
This problem motivated Alan Blinder - a former Vice-Chairman of the Federal Reserve Board - and his
colleague John Morgan at Princeton to adopt a different approach: carrying out two 'laboratory
experiments' using groups of Princeton students to test whether groups do indeed make decisions
differently.2 Their first experiment was purely statistical: subjects were asked to identify when a one-off
change in the proportions of red and blue balls in an electronic urn took place. The second asked
participants to play a simple monetary policy game, setting a short-term interest rate in order to
minimise a loss function described by deviations of unemployment and inflation from desired target
levels. The data generating outcomes for this hypothetical economy came from a two equation
macroeconomic model of a fairly standard kind. Again a structural change - this time to the "natural"
real rate of interest - would occur at some point during the game, and, by observing data generated by
this economy, players would need to learn about the change in structure in order to set the appropriate
interest rate.
All the students who participated played both as individuals and in a group. In both experiments
success could be measured on a quantitative scale, and both led to a common conclusion: that
decisions made by committees were superior to those of individuals. How robust was this result? And
what explained it?
Last year, a team from the Bank of England attempted an exercise very much like Blinder and
Morgan's monetary policy experiments using a sample of just under 200 economics students from the
London School of Economics.3 Using a simple macroeconomic model that was broadly representative
of the UK economy, the experiments examined how the performance of groups differed from that of
individuals. And again they found striking evidence that committee decisions were superior.
In the Bank study, each participant was asked to play a simple, computer based, monetary policy
game sixteen times: four rounds as individual policy makers, followed by eight rounds in a committee
of five players, and finally a further four rounds as individuals. The committee stages were divided into
two parts: four rounds where committee members were not allowed to discuss their decisions -
although they could observe the unattributed votes of other players - and a further four rounds where
discussion was permitted. As a control for learning, the order of the 'discussion' and 'no discussion' set
of games was randomised across the committees.
Each game consisted of ten periods of play in each of which the individual or committee had to decide
what interest rate to set in response to the data for output and inflation generated in the previous
period. In the committee stages, the majority - or more precisely the median - vote was implemented
once all committee members had entered a vote into their respective computers.
Participants were told nothing at the start of the experiment about the structure of the economic model
with which they were playing, or the disturbances that it was subject to, other than that a structural
change occurred at some point during each play of the game. In short, they were operating - much like
real-life monetary policy makers - in uncertain conditions, doing their best to identify the shocks that hit
the economy and offsetting their impact by adjusting the short-term interest rate.
To quantify their performance, players were scored according to their ability to keep inflation close to a
pre-specified target and to minimise output fluctuations, and were paid a modest amount for doing so.
Chart 1 shows the pattern of average scores over the different stages of the game. Three features are
striking:
(i) The significant upward trend in the results. Players clearly learned how to play the game as
time went on.
(ii) The large upward movement in scores when players moved to committee decision-making.
(iii) The large downward move in scores when participants returned to playing as individuals.
These results support the idea that committee decisions represent a significant improvement over
those of the individuals that comprise them. What might account for these results? The Blinder and
Morgan and Bank studies suggest two main reasons. First, collective decision-making appears to give
more weight to the better and less weight to the worse committee members, as judged by their scores
when playing the game as individuals, than would be implied by taking the mean of individual
performance. The best player had some influence on the decisions of the group of which they were a
member. And the impact of the worst player was offset by majority voting. In other words, the median
score of the players in the individual rounds was significantly above the mean, implying that the
average was being pulled down by a minority of relatively bad players.
Second, there was also evidence from the experiments consistent with the hypothesis that committees
enable all members to improve their performance by sharing information and learning from each other.
And it was striking that the performance of committees was on average somewhat better than that of
the performance of the single best player on the committee when playing alone. So in terms of group
decisions, it appears that the whole is different from - and generally better than - the sum of its parts.
Producing the perfect design of a committee structure that would make the best decisions is a task
with no simple answer. But the MPC embodies several features that seem desirable. First, there is a
clear objective given to the Committee from outside, in this case by the government. Second, the
members are chosen for their technical ability. Third, the votes on the MPC are transparent, and
hence members can be held accountable. The merit of individual accountability is that each individual
in the group has a genuine incentive to reach a good decision. This aspect leads us directly into my
second question.
2. Second, does it matter that there are differences of view among Committee members?
From the outset, commentators have been unable to resist labelling members of the Committee as
either 'hawks' or 'doves'. I have argued before that it makes no sense to use these descriptions
because each member of the Committee has the same objective. Members of the MPC cannot
entertain closet views about their desired inflation rate because they will be held personally
accountable for their judgments about the level of interest rates necessary to meet the mandated
inflation target. As circumstances change, it is easy to imagine that 'hawks' shall be 'doves' and
'doves' shall be 'hawks'.
But that is not to say that differences of opinion do not, and should not, exist amongst committee
members. If part of the reason for the improvement of groups over individuals is their pooling of
knowledge, then differences of opinion during the discussion that takes place at each MPC meeting
should be central to the Committee's performance. As The Economist put it back in 1998 (when there
were only eight serving members):4
4
Economist, 18 April 1998, p. 28.
'With the economy on the turn, the MPC has to sift mixed evidence... It would be
remarkable if eight intelligent, well-briefed economists could be of one mind.'
But this point is not always readily understood, even by the most astute commentators. In July 1998
the Financial Times suggested:
'...the MPC bears a closer resemblance to a post-graduate seminar than to a
forum for strategic decision making... To put [several] economists in the same
room is to invite what one commentator has called paralysis by analysis.'
The Times
And in the same month, described the MPC as 'a committee bursting to the brim with
individual opinions' implying that 'periods of badly co-ordinated and erratic behaviour are only to be
expected'.
But it is precisely the exploration of alternative views about what is happening in the British economy,
and the discussion of these views by the Committee in a spirit of investigation not advocacy, that is
central to the pooling of knowledge through which committees reach decisions that are superior to
those taken by individuals. I think that is increasingly understood by commentators, and helps to
explain why split votes are now regarded as normal and not a source of great excitement. It is,
nevertheless, important that there are no ideological differences among Committee members that
would make rational debate difficult, and, in this respect, the Committee has so far been fortunate.
A famous 1970s laboratory experiment also showed the value of a frank exchange of views within a
committee.5 It featured groups of senior managers working together to solve a complicated problem in
a game called 'Lost on the Moon'. Subjects were asked to rank a list of objects in order of their
necessity for survival after their spaceship had inadvertently crash-landed on the moon. It was found
that the best-performing groups - or those which got closest to the ranking suggested by experts at
NASA - were those which were least consensual in the early stages of discussion, exploring all
possible avenues and ideas. Groups which established a common consensus quickly were often
ineffective, suggesting that at least some disagreement is beneficial for committee performance
because it stimulates discussion and hard thinking. Differences of view on our Committee are an
honest reflection of the uncertainty about both the data and the structure of the economy.
To date there have been 61 meetings of the Monetary Policy Committee. The votes cast at those
meetings are summarised in Table 1. It includes the votes of this month's meeting which were
published this morning. At those 61 meetings, interest rates were raised on nine occasions, were
lowered on 14 occasions, and left unchanged at 38. At the first seven meetings during 1997, decisions
were reached unanimously. The number of voting members varied between five and eight as the
membership of the Committee built up. The first dissenting vote was cast in January 1998. Since the
beginning of 1998, the voting has been divided reasonably evenly among all possible combinations of
votes (remember that there were nine voting members only from June 1998 following the passage of
the Bank of England Act.) Of the 54 meetings since January 1998, four dissenting votes have been
cast on six occasions, three on seven occasions, two on eleven occasions and one on 16 occasions.
At only 14 meetings has the vote been unanimous, and no one - sensibly - has seen fit to abstain, so
that during the past five years the frequency of unanimity among the Committee has been little more
than one in four. Differences of view have become accepted as the norm, and this appears to have
done little damage to the credibility of the Committee.
Nor has there been much sign of "blocs" of votes, whether internal or external. There have been
15 occasions on which members of the executive of the Bank have been on opposite sides of the
vote, and 37 occasions when externals have found themselves divided. It is true to say that dissenting
votes have been more common among external than executive members. Of the 83 dissenting votes
cast during the history of the MPC, 25 have been cast by executive members and 58 by external
members. But of these 58, no fewer than 44 are accounted for by three of the eight external members,
Willem Buiter, DeAnne Julius and Sushil Wadhwani. For the remaining five external members, the
propensity to be in the minority has been very similar to the Bank executive (excluding the Governor),
with dissenting as a proportion of total votes at 12% and 11% respectively.
Moreover the differences in votes have been small. On only four occasions has the difference between
the highest and lowest interest rate voted for exceeded 25 basis points, and, interestingly, all four were
between August 1998 and April 1999, a period of great uncertainty about whether there would be a
downturn in the world economy that did not in fact materialise. Since then differences of view have
never exceeded 25 basis points. The average difference between the interest rate cast by the member
voting for the highest average level of rates and the member voting for the lowest average level of
rates is less than 15 basis points! Such a small difference hardly corresponds to a major difference of
view about the outlook for inflation.
3. Third, has the Committee explained clearly the reasons for its decisions?
Transparency has been at the centre of the monetary policy framework since 1992 when it was
recognised that clear explanations of policy would help to anchor inflation expectations on the target.
Inflation
The first major step in enhancing transparency was the Bank's Report, which first appeared in
February 1993, and was subsequently enhanced by publication of the minutes of the meetings
between the Chancellor and Governor. That transparency was given a further boost by the creation of
the Monetary Policy Committee where the votes of all members are published along with the minutes
of the discussion at MPC meetings.
Despite its record on transparency, questions have been raised about whether the MPC could go
further. Do the published minutes reveal enough about individual views? Should there not be
individual paragraphs in the minutes explaining the position of each member? Why does the
Committee not publish a forecast corresponding to the path of interest rates that it feels most likely to
be necessary to meet the inflation target? Why does the central projection of the forecast always seem
to end up at close to the target of 2.5%?
It is helpful to step back and ask three more fundamental questions. First, what is the MPC trying to
communicate? Second, how should it communicate? Third, what is the role of the inflation forecast?
The basic message which the MPC is trying to communicate is that, over the medium term, inflation
should be expected to average 2.5%, and that the Committee will respond to events as they unfold in
order to keep inflation on track to meet that target. Hence the Committee needs to explain its view of
the current state of the economy, how and why it has reacted to events that have already unfolded,
and what it believes are the risks lying ahead. All of this can be encapsulated in its "policy reaction
function". Commentators and others may form their own views about the likelihood of various
economic shocks occurring, and in that respect it is more important for them that the Committee
explains its policy reaction function than attempts to provide guidance on the likely future path of
interest rates. And when the Bank of Canada tried to anticipate the likely future path of monetary
conditions, it found that, despite its clear explanations of why the future could not be easily anticipated,
markets took those anticipations as commitments, and were surprised when unforeseen events
resulted in different policy outcomes. In contrast, the MPC does not attempt to anticipate its own
decisions.
In addition to explaining the Committee's views on the economy, and the balance of risks to inflation,
there is a second important role for communication. That is to explain the views of the nine individual
members of the Committee so that they can be held accountable for their judgments. There is,
therefore, an inherent tension between a system of nine individually accountable members, with their
associated views, and a Committee from which a single decision emerges that requires a clear
explanation each month. The former produces, as I have argued, better decisions; the latter is
important for the predictability and thus the efficiency of monetary policy. The communication strategy
of the MPC must provide a balance between these two objectives, a point acknowledged in the report
by Don Kohn on the procedures of the MPC.
The need to achieve such a balance leads directly to the question of how the Committee should
communicate its thoughts. The minutes of the MPC meetings, now released only 13 days after the
decision itself, provide a detailed explanation of the issues that confronted the Committee and the
arguments that were made during the meeting. They also contain the votes of individual members.
The Committee has discussed, but rejected, the proposition that the minutes should contain individual
paragraphs summarising the views of each member in turn. The reason is that such a procedure
would alter the nature of our meetings quite radically. At present, they are a free-flowing discussion in
which members discuss propositions and counter propositions in a spirit of mutual enquiry rather than
an exchange of fixed and conflicting views. Discussion focuses on the relative merits of different
possible explanations for the current state of the economy. If each member faced a deadline by which
they had to produce a polished paragraph summarising their views, members would enter the meeting
with such a paragraph in draft form and the spontaneity of the discussion would be lost.
For the same reason, it is not clear that the publication of transcripts of meetings enhances
transparency. The Federal Reserve provides a useful case study. Prior to 1994, members of the
FOMC were largely unaware that monetary policy discussions were being transcribed verbatim from
audio recordings of the meetings. Congress learned of the availability of the transcripts shortly after
this, and in February 1995, insisted that they be published with a five-year lag. Once committee
members became aware that their meetings were being recorded, the structure of the discussion
appeared to change. Before 1995 meetings had begun with prepared speeches followed by a
freeflowing debate characterised by a frank exchange of ideas. But after 1995, there appears to be a
much greater tendency for meetings to become an exchange of prepared statements, and some of the
colour of the previous discussion may have been lost.
Explanations of decisions in the form of press statements issued at the time of the announcement of
decisions on interest rates have become less frequent. But this is principally because there have been
fewer interest rate changes recently. In its first three years, the Committee moved rates 16 times and
issued press statements on 14 of those occasions. It also issued two statements when it had not
moved rates. Over the past two years the Committee changed rates seven times, accompanied by six
statements, with no statements when rates were left unchanged. The purpose of a press statement is
to explain a decision reached, by definition by a majority of the Committee. Because it is brief it cannot
do justice to the richness of the discussion at the Committee, and the balance of views is not
represented. Hence the Committee has come to the view that, by and large, it is better to wait until the
publication of the minutes when a fuller view of issues and views can be provided. That is not to say
that press statements will not appear in future, but to stress that their purpose is limited to explaining a
decision that might be unexpected, irrespective of whether that is a change or no change in rates.
On the whole, the minutes have been successful in creating a wider understanding of the issues
discussed by the MPC, and have a devoted, if small, following. The Inflation Report, which pre-dates
the MPC, has a broader objective in setting out a comprehensive view of the current state of the
economy, and describing the outlook for inflation in terms of a forecast over a two-year horizon. The
Committee puts great weight on explaining the forecast in terms of probabilities. Hence it has adopted
the famous coloured fan charts for its forecasts for both growth and inflation. But there remains some
confusion about the role of the forecast. With the advent of the MPC, the tensions between explaining
nine individual views and presenting a coherent account of the Committee's view of the economy have
complicated the production of the forecast. The Inflation Report now contains an explicit description of
differences of view among the Committee in respect of both the central projection and the risks to the
forecast, as well as the "best collective judgment", or majority view, of the outlook. But the main focus
of the Inflation Report is to present a collective view. To publish nine individual fan charts would hardly
increase transparency, and the differences of judgment have to date been sufficiently small that it
would be difficult for commentators to observe significant differences among those charts. This tension
between the need to explain the diversity of members' views, and the need to provide a clear rationale
for the single decision, suggests that the Committee may need to explore further ways of putting
across its collective view.
It should be clear that there are both benefits and costs to a group decision-making process. The
transparency and accountability of individual views helps to make better decisions. But it also
complicates the communication of the decision to a wider audience, whose expectations of inflation
matter for economic behaviour. The avoidance of confusion requires some forbearance by individual
members of the Committee, and a clear understanding of which forms of communication are
appropriate to explain individual views and which forms are suitable for explaining the reasons for a
collective decision. I am sure that the Committee will learn more about how best to achieve this
balance as time goes by.
4. Fourth, does the MPC require reform?
Despite its youth, at least in central banking terms, the MPC has not suffered from lack of advice on
how to improve itself. There have been six reports from the Treasury Select Committee, two reports
from the House of Lords' Committee on the MPC, reports by a commission of the Conservative Party
and by the Liberal Democrats, a report by the Engineering Employers' Federation, recommendations
by many economists, including former MPC members, and, last but not least, the report commissioned
by the Bank of England itself by Don Kohn, a senior staff member of the Federal Reserve Board and
recently nominated by the President for appointment to the Board of Governors. Overall, the verdict on
the Committee has been broadly positive. For example, in his 2001 review of the operation of
monetary policy in New Zealand, Professor Lars Svensson describes the Bank of England and the
Swedish Riksbank as examples of "best practice" monetary policy.
Suggestions for improvement from the various groups cover the following areas: the definition of the
inflation target; terms, appointments and composition of the membership of the MPC; arrangements
for publication of the minutes; the forecast produced by the MPC; and, finally, a miscellaneous
collection of technical matters.
The precise definition of the inflation target, and its numerical value, can be debated at length. What is
important is that the target is for inflation and not additional objectives that would lead to confusion
about the Committee's aims.
On the Committee itself various suggestions have been made: to extend the terms of appointment of
members of the MPC, to make those longer terms non-renewable, and to appoint people with more
diverse backgrounds. By far the most fundamental of these suggestions is the proposal to appoint
representatives of different industries or regions to the Committee, as opposed to monetary policy
experts. That would change the nature of the debate and undermine the mutual confidence of
members of the Committee in each other if it were felt that some were representing a specific interest
group. With experience of the MPC, I think that this argument has come to be accepted.
The proposal that the minutes of MPC meetings should include more description of individual views I
discussed earlier. The Committee has been opposed to such a change for the reasons I gave. In its
early days the Committee was sensitive to the view that the minutes, then published six weeks after
the meeting, should be published earlier, and it shortened that lag to 13 days in October 1998.
The forecast process has attracted much attention, and was discussed at length in the Kohn Report.
Presenting the forecast in terms of a fan chart, in order to highlight the balance of risks to the outlook,
has proved successful. But it has proved more difficult to explain the role of a projection conditioned
on the assumption of constant official interest rates. So the Committee also publishes a forecast
conditioned on market interest rates, in order to provide a guide as to how the forecast depends upon
the profile of short-term interest rates.
The Committee has had more problems in trying to explain that there is no mechanical link between
the central projection of the forecast for inflation two years ahead and the policy decision. This is for
several reasons. First, the view of inflation both prior to and after the two-year horizon is important too.
The optimal horizon over which to bring inflation back to target depends on the shock which moved
inflation above or below target. Second, the risks to inflation around the central projection (defined as
the mode of the distribution of inflation at future points) are also relevant to the policy decision. Third,
there may be some risks to which the Committee does not wish to respond until they have
materialised. But the Committee will continue to explain how its outlook for inflation relates to the
policy decision, and, over time, we hope that this educational effort will pay off.
Finally, there have been several miscellaneous suggestions for change to the MPC. First, the MPC
has been accused of meeting too frequently and, as a result, changing rates too often. The EEF report
suggested that the Committee meet only eight times a year, as does th