IS THE Fed biased? Even asking the question is enough to ruffle feathers at that august institution. Yet new research suggests that the voting behaviour of the Fed's key policymakers may be surprisingly biased—and, more importantly, in a way that has implications for the European Central Bank.
The Fed's founders were anxious to eliminate the possibility of bias, either in favour of one region against another, or of large banks against small. Indeed, fear of bias had scuppered two earlier attempts to create an American central bank. The complex voting system of the Fed's main policy body, the Federal Open Market Committee (FOMC), is intended to ensure the broadest range of views.
Research into possible bias has tended to concentrate on the voting behaviour of the 12 Federal Reserve Bank presidents, who represent each of the Fed's districts. Only five have voting rights: the president of the New York Fed, and four others on a rotating basis. The votes of this group show the influence of regional, as well as national economic developments. As a guard against this, the seven members of the Washington-based Board of Governors, who have permanent voting rights, outnumber them.
But might the governors also be biased? Ellen Meade, of the Centre for Economic Performance at the London School of Economics, and Nathan Sheets, who is, as Ms Meade used to be, a Fed economist in Washington, examined the voting records of all FOMC members, governors included, between 1978 and 2000*. As a proxy for regional economic trends, they used unemployment rates, calculated for each Fed district (one of the Fed's obligations is to maximise employment); and they focused on dissents from FOMC majority votes.
It turns out that governors tend to vote against the majority when there is a significant gap between the unemployment rate in their “home” region and the national rate. When the regional rate was, on average, 0.7% higher than the national, a governor would vote against the majority view and in favour of easier monetary policy; when it was, on average, 1.1% lower than the national rate, he or she would vote in favour of tighter policy.
Previous research has shown that the board members are generally less hawkish than the district bank presidents. The analysis by Ms Meade and Mr Sheets confirms that board members appear more likely than the bank presidents to dissent in favour of easier policy, and less likely to press for tighter policy against the majority view. It also shows that this is because overall the governors are more sensitive to regional developments than are the district bank presidents.
Meanwhile in Europe
Is this regional bias among FOMC members something found in other central banks? What about the supra-national European Central Bank (ECB), whose structure bears a superficial resemblance to the Fed's? Hard facts are difficult to come by because of the European bank's secretive working methods: it does not publish records of meetings.
The ECB's Governing Council, like the FOMC, comprises two groups: six policymakers based in Frankfurt, plus the heads of the 12 national central banks in the euro area. But at the ECB voting does not rotate—all 18 members have an equal say. That immediately builds in the possibility of national bias, since six countries—currently Finland, France, Germany, Italy, the Netherlands and Spain—have two representatives on the governing council.
Ms Meade and Mr Sheets were not deterred by the absence of voting records. They devised an experiment to test whether ECB policy decisions might be affected by national loyalties. Since (unlike the Fed) inflation is the ECB's sole policy objective, they made a working assumption that each council member would cast his vote according to the difference between national and euro-area inflation rates, and that he would vote in a certain way if that difference were above a certain threshold. With one exception, it seems that all the interest rate changes made since the ECB started in 1999 were those which would have resulted if all council members had voted simply on the basis of differences in their national and euro-area inflation rates.
There has long been a suspicion that policymakers—not just in the ECB but in a variety of European institutions—retain at least some loyalty to their home country. That, after all, must be one reason why member governments expend so much effort and political capital in trying to secure posts for their own nationals.
So should the ECB try to reduce the scope for national bias in its policymaking? Reform of the ECB's structure seems inevitable if only because enlargement of the European Union, and of the euro area, threatens to make the existing structure unwieldy. A reduction in the size of the governing council, or at least in the number of members entitled to vote, seems likely at some point. The Nice treaty, agreed in 2000, provides for reforms to be proposed.
A reform being proposed by some academics (and considered in some parts of the European Commission) would tilt the ECB towards the Fed, and go even further, by restricting voting to the permanent, Frankfurt-based council members. Given what Ms Meade's and Mr Sheets's findings appear to show, that might not be a reform in the right direction.