5 to 4

Narayana Kocherlakota:

5 to 4: On Friday, the Policy Board of the Bank of Japan decided to lower its deposit rate into negative territory for the first time.  The vote was five to four.  In this post, I argue that US monetary policy would be stronger if the Federal Open Market Committee (FOMC) were willing to issue statements and take actions that were supported by such narrow margins.

As is well-known, the FOMC operates by consensus.  No decision has had more than three No votes in at least twenty-five years.  There has not been a No vote by a governor in ten years, and there has not been more than one No vote by a governor at a meeting in over twenty years.  (See this great article by Thornton and Wheelock for a deeper review.)  

This decision framework is not statutory.  Rather, it is a Committee norm.  The norm is buttressed by Fed watchers and the media, who often refer approvingly to the absence of dissents at a meeting.  (Even today, this FT article refers to the lack of dissents at the December 2015 meeting as being a sign of a successful liftoff.)

This tradition of consensus has three main deficiencies. 

First, consensus creates a strong status quo bias that reduces the sensitivity of monetary policy to incoming data.   The current Committee norms imply that it requires a super-majority of the FOMC to implement a change in direction.  Without that super-majority, the Committee tends to stick to its prior course.   This automatically makes monetary policy relatively insensitive to incoming information.  

Second, the tradition of consensus opens up the possibility that relatively small minorities of FOMC voters can have a disproportionate influence  on monetary policy decisions.   For example, the above history suggests that the FOMC is following a practice under which all decisions need near-unanimous support from the governors.  If so, it becomes theoretically possible for a bloc of one or two governors to exercise veto rights over changes in the direction of monetary policy.

Finally, and perhaps most troublingly, the desire/need for consensus tends to strip collective Committee statements of their clarity.   (See a recent Wall Street Journal op-ed by Charles Plosser for a similar concern.)  For example, here’s how the current FOMC statement describes the conditionality of the path for the fed funds rate: 

“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”

This length of this list of conditioning variables helps create consensus, but it also serves to reduce the public’s understanding of the overall FOMC strategy.  This uncertainty can be a drag on the effectiveness of policy. 

Bold policy moves often engender significant disagreement.   Policy-making bodies must have cultures that can allow those decisions to get made, despite that disagreement.   Clearly, the Policy Board of the BOJ has that kind of culture.   I worry that the FOMC, with its emphasis on consensus, does not. 

I’ll write more about the potential economic importance of the BOJ’s move in a later post.  For now, I’ll simply say that, given the challenges facing the global economy, I applaud Governor Kuroda’s willingness to lead the BOJ in this new direction.