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Chapter 3. Monetary Policy, Intraparty Conflict, and Central Bank Independence
- University of Michigan Press
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CHAPTER 3 Monetary Policy, Intraparty Conflict, and Central Bank Independence The design of central bank institutions represents an explicitly political choice. Therefore, an explanation of the variation of central bank institutions must consider politicians' interests, particularly their desire to attain and hold office. It must take into account how different electoral, legislative, and government institutions affect politicians' incentives over central bank structure. Finally, it must explain why politicians remain committed to a particular central bank institution, even if preferences over policy outcomes change, and describe the conditions under which politicians may alter the institution. In this chapter, I develop an explanation of the choice of central bank institutions , focusing on the potential for intraparty conflict over monetary policy and the principal-agent relationship between backbench legislators, coalition partners, and the cabinet. At a fundamental level, party legislators and coalition partners delegate policy responsibility to the cabinet, allowing legislators and coalition partners to remain ignorant of issue areas while cabinet ministers develop expertise in their portfolio. Cabinet ministers, however, can exploit their informational advantages over backbench legislators and coalition partners to implement their own preferred policies-policies that may not benefit the party as a whole. The informational asymmetries of the policy process therefore can create potential conflicts between party legislators, coalition partners, and cabinet ministers. I argue that an independent central bank can help alleviate some of these conflicts by supplying credible information about monetary policy. The nature of this intraparty principal-agent relationship conditions the choice of central bank institutions. In situations where conflict over monetary policy between party legislators and cabinet ministers is likely, politicians will 37 38 Banking on Reform choose an independent central bank. If conflict is unlikely, politicians will opt for a dependent central bank. Consequently, variations in the potential for intraparty conflict can help explain differences in central bank institutions across systems and over time. This chapter develops the logic of the argument. The first section discusses how the informational asymmetries ofthe monetary-policy process affect the incentives oflegislators, coalition partners, and cabinet ministers over the choice of central bank institutions. The second and third sections explore the institutional conditions under which information from a central bank bureaucrat can solve the potential conflicts created by the informational asymmetries of the policy process. The fourth section lays out the observable implications ofthe argument. Monetary Policy, Political Parties, and Delegation I begin with the assumption that politicians and parties are fundamentally motivated by a desire to retain office. Before any concern with either policy or "pork:' politicians and parties must hold office. Politicians' preference for attaining (and retaining) office provides them with policy incentives. Because voters generally use economic outcomes, rather than policy outputs, to evaluate candidates and parties, politicians and parties must pursue policy outcomes that satisfy the preferences of their constituents. But in a complex issue area such as monetary policy, politicians may have difficulty choosing policies that will produce desired outcomes (Krehbiel 1991). First, changes in monetary policy do not always have expected consequences. Monetary policy has indirect effects throughout the economy, often with uneven and variable lag times (Beck 1987; Friedman 1968). These outcomes are vulnerable to exogenous shocks and international influences. Second, changes in monetary policy may have different effects across economic sectors. Higher interest rates, for instance, may benefit banking and financial interests but hurt firms in the construction industry. Third, monetary policy takes time to affect the econ0my . Politicians must consider this lag to deliver outcomes in a timely manner. Finally, the relationship between policy and outcomes may itself change as new technology evolves or as individuals modify their behavior in response to current regulations. The advent of electronic banking, for example, significantly altered the conduct of monetary policy, forcing policymakers to reconsider how they estimate the money supply. Successful monetary policy-making therefore requires that politicians invest resources to develop the expertise necessary to predict the consequences of a variety of policy proposals. [54.160.243.44] Project MUSE (2024-03-29 00:34 GMT) Monetary Policy, Intraparty Conflict, and Central Bank Independence 39 Party Legislators Although individual legislators want policy outcomes to reflect the preferences of their constituents, each legislator must budget his or her limited time and resources toward achieving reelection. These individual electoral incentives create collective dilemmas for the legislative majority in the production and implementation of legislation (Kiewiet and McCubbins 1991). Legislators face a dilemma in the development of policy expertise (Gilligan and Krehbiel 1989, 1990; Krehbiel 1991). Information about the relationship between policy...