Behind closed doors: Revealing the ECB's decision rule

Abstract

This paper aims at discovering the decision rule the Governing Council of the ECB uses to set interest rates. We construct a Taylor rule for each member of the council and for the euro area as a whole, and aggregate the interest rates they produce using several classes of decision-making mechanisms: chairman dominance, bargaining, consensus, voting, and voting with a chairman. We test alternative scenarios in which individual members of the council pursue either a national or a federal objective. We then compare the interest-rate path predicted by each scenario with the observed euro area's interest rate. We find that scenarios in which all members of the Governing Council are assumed to pursue Euro-area-wide objectives are dominated by scenarios in which decisions are made collectively by a council consisting of members pursuing national objectives. The best-performing scenario is the one in which individual members of the Governing Council follow national objectives, bargain over the interest rate, and their weights are based on their country's share of the zone's GDP. Behind closed doors: Revealing the ECB's Decision RuleAbstract: This paper aims at discovering the decision rule the Governing Council of the ECB uses to set interest rates. We construct a Taylor rule for each member of the council and for the euro area as a whole, and aggregate the interest rates they produce using several classes of decision-making mechanisms: chairman dominance, bargaining, consensus, voting, and voting with a chairman. We test alternative scenarios in which individual members of the council pursue either a national or a federal objective. We then compare the interest-rate path predicted by each scenario with the observed euro area's interest rate. We find that scenarios in which all members of the Governing Council are assumed to pursue Euro-area-wide objectives are dominated by scenarios in which decisions are made collectively by a council consisting of members pursuing national objectives. The best-performing scenario is the one in which individual members of the Governing Council follow national objectives, bargain over the interest rate, and their weights are based on their country's share of the zone's GDP.

The Monetary Policy of the ECB: Caring for the Weakest Links

“…Our results suggest that these models explain actual ECB policy even better than GDP based bargaining models that have been highlighted in the previous literature (see, e.g., Hayo and Méon (2013)). Thus, the ECB seems to have emphasized the needs of countries that fare economically worse disproportionately high than the euro area average even before the advent of the financial crisis.…”

“…A frequently employed safe alternative is to simply use the original rule suggested by John Taylor (Taylor, 1993), which is completely agnostic of specific calibrations, but completely misses the peculiarities of the individual countries. To make our analysis as independent as possible of any particular choice of method, we follow Hayo and Méon (2013) who use the simple average of the three specifications by Eleftheriou, Gerdesmeier, and Roffia (2006), Hayo (2007) and Taylor (1993). In section VI we show that our results are robust to using each of the three above time series of counterfactual interest rates separately.…”

“…They find that business cycles within the euro area only converge if more than proportional weight is attached to small member countries. Similarly, Hayo and Méon (2013) estimate counterfactual interest rates for the euro area countries via Taylor rules. These nationally preferred rates are aggregated according to different decision models and compared to the actual rates set by the ECB.…”

“…This period offers substantial variation both in the general economic climate and ECB policy. If the ECB was ever able to conduct monetary policy independent of national political interests, it was during 9 See, e.g., Bénassy-Quéré and Turkish (2009) and Hayo and Méon (2013). 10 We thank Bernd Hayo and Pierre-Guillaume Méon for generously sharing their data with us.…”

“…the interest rates national central banks would set if they still had the discretion to do so. As there are numerous ways of deriving such counterfactual interest rate paths, we follow Hayo and Méon (2013) and build our analysis n a broad set approaches by employing the average of estimates based on Hayo (2007), Eleftheriou, Gerdesmeier, and Roffia (2006) and Taylor (1993). We then employ various potential decision models to aggregate the counterfactual national interest rates and test which of the resulting interest paths fits best to the actual monetary policy in the euro area.…”