Central Bank Boards Around the World: Why Does Membership Size Differ?1

Helge Berger; Tonny Lybek; Volker Nitsch

doi:10.5089/9781451865417.001.A001

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Central Bank Boards Around the World: Why Does Membership Size Differ?1

Author: Mr. Helge Berger, Mr. Tonny Lybek, and Volker Nitsch¹

¹ 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Contributor Notes

Authors’ E-Mail Addresses: hberger@wiwiss.fu-berlin.de, vnitsch@wiwiss.fu-berlin.de, tlybek@imf.org

Publication Date:: 01 Dec 2006

eISBN:: 9781451865417

ISBN:: 9781451865417

Language:: English

Keywords:: WP; MPC size; exchange rate; monetary policy; MPC member; implementation board

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This paper analyzes empirically differences in the size of central bank boards across countries. Defining a board as the body that changes monetary instruments to achieve a specified target, we discuss the possible determinants of a board's size. The empirical relevance of these factors is examined using a new dataset that covers the de jure membership size of 84 central bank boards at the end of 2003. We find that larger and more heterogeneous countries, countries with stronger democratic institutions, countries with floating exchange rate regimes, and independent central banks with more staff tend to have larger boards.

Abstract

I. Introduction

Monetary policy may be a “science,” but it is hardly an exact one. Given that policy decisions are surrounded by uncertainty, the way central banks exploit information and agree on decisions clearly matters for the quality and success of monetary policy. As a result, recent research has emphasized the importance of central bank organization—and in particular the size and structure of central bank boards or monetary policy committees (MPCs)—for monetary policy.³,⁴

The question of how many people should decide on monetary policy has recently also stirred interest on practical grounds. In Europe, the possible increase in euro area membership has triggered an intense debate on the optimal design of the decision-making process in the European Central Bank’s (ECB’s) 18-member Governing Council, in which there is at least one representative from each member country (e.g., Baldwin and others 2001; Berger, de Haan, and Inkler, 2004). As a result of this discussion, the ECB has generally limited the (future) number of voting members to 21. This, however, appears to be still a large number compared, for instance, with the Bank of England’s Monetary Policy Committee (9) or the Federal Reserve’s Federal Open Market Committee (12). Of the 82 central banks surveyed by Fry and others (2000), 55 institutions (67 percent) had policy committees with 5– 10 members.⁵

In this paper, we aim to characterize differences in the membership size of decision-making bodies of central banks around the world. Since central banks often operate various boards, committees, and councils, we focus on the central bank’s implementation board (or MPC) that makes decisions on whether and when to change policy instruments to achieve a given monetary policy target. Appendix I and Lybek and Morris (2004) provide a more detailed discussion of the various functions of central bank boards.

In principle, the optimal size of an MPC depends on the costs and benefits.⁶ The benefits from having more people on a board are mainly related to improvements in information processing and to ensuring that there are checks and balances owing to the different groups they represent. A larger number of board members should involve a broader range of experiences and perspectives and, hence, (ideally) be better in dealing with uncertainty and processing relevant information an argument that is loosely based on Condorcet’s jury theorem.⁷ At the same time, decision making typically becomes more difficult as board size increases. As membership size increases, different views are harder to reconcile, and discussions at board meetings are likely to become more time consuming. As a result, decisions might be delayed or require more effort, thereby weakening the effectiveness of monetary policy. Also, individual representation at the board becomes less important as MPC size increases so that the gains from diversity of skills and perspectives of members tend to become smaller for larger central bank boards. In fact, members may even have an incentive to “freeride” on the information-processing efforts of others as the number of decision makers increases.

The exact structure of the trade-off between costs and benefits determining optimal MPC size will depend on country-specific characteristics. For instance, the argument to increase board size to achieve better information processing appears to be of particular relevance when an economy is large or characterized by considerable diversity across regions and industries. Similarly, a country’s political institutions may matter. For instance, in an autocratic regime, a larger MPC may provide useful insulation from political pressures.⁸,⁹ In contrast, less democratic regimes may prefer a smaller board for the same reason. Finally, MPC size should also be affected by the institutional functions performed by a central bank, the type of central bank autonomy, and other elements of central bank design. If the central bank enjoys full autonomy over both policy targets and instruments, the MPC may be larger than when the central bank’s autonomy is more limited. In view of the considerable cross-country variation along economic, political, and institutional dimensions, Goodfriend (2005, p. 85) argues that “the efficient size of a policy committee might vary across countries.”¹⁰

In the following sections, we analyze empirically whether country-specific features help to explain differences in MPC size. Basing our research on a simple theoretical model, we illustrate the linkage between country-specific features and the size of central bank boards in more detail. We then explore the empirical association between a wide variety of country characteristics and MPC size using a new cross-country dataset that covers 84 central banks around the world at the end of 2003. Our dataset utilizes information on MPC size and other (de jure) central bank characteristics from Lybek and Morris (2004) and combines it with other macroeconomic, structural, institutional, and central bank data.

We find that board size is strongly and plausibly associated with a number of country-specific characteristics. Our results indicate, for instance, that MPC size is positively correlated with measures of country size and (population) heterogeneity, thereby providing strong empirical support for the theoretical and experimental finding that MPC size is affected by a central bank’s information-processing requirements. We also find that MPC size is related to a country’s political institutions, with more democratic countries having, on average, larger boards. Finally, MPC size is often associated with other central bank characteristics. Central banks that have greater formal autonomy over objectives and targets, a more complex monetary strategy, a longer history, and more staff typically have more board members who serve, on average, shorter terms.

The remainder of the paper is organized as follows. In Section II, we provide a detailed discussion of possible determinants of MPC size. Section III presents the data and the empirical results, and Section IV provides a brief conclusion.

II. Possible Determinants of Central Bank Board Size

The size of the central bank board, or the MPC, is an important feature of central bank design. It is likely to reflect costs and benefits of an increasing number of board members (Berger 2006; Sibert 2006) as well as the political environment in which the decision on MPC size is made. In fact, one way to picture the decision process is purely political.¹¹ For instance, the number of central bank board members could be the result of a bargaining process involving different interest groups (e.g., the financial sector, trade unions, or export industries) aiming at direct or indirect representation in the MPC, possibly with some inertia caused by path dependence.¹² Alternatively, the decision on MPC size could take the form of a conscious design decision of a decision-maker based on social or private preferences and subject to more or less binding political constraints. Provided the central bank independence paradigm is acknowledged, the design-scenario may be more relevant for boards that primarily make decisions on whether to change monetary policy instruments to achieve a specified target (instrument autonomy) than for policy boards that are also involved in determining the target of the central bank (target autonomy) or even deciding on its primary objective (goal autonomy), which is much more normative.¹³ Following the more recent literature, we will organize our discussion of the determinants of central bank board size around the trade-off of some of the more obvious costs and benefits.¹⁴

A. The Basic Trade-Off

On the benefit side, the most prominent argument in favor of increasing the number of MPC members is that larger MPCs could be in a better position to process, analyze, and interpret economic information—ultimately leading to better monetary policy decisions—than individuals relying mostly on their own information and judgment. Working in a notoriously uncertain macroeconomic environment, multiple MPC members are able to pool information and exploit divisions of labor in information processing.¹⁵ Among others, the argument has been put forward in theoretical terms by Gerlach-Kristen (2006) and Berk and Bierut (2004); supportive experimental evidence is produced by Blinder and Morgan (2005) and Lombardelli et al. (2005).¹⁶ Gerling et al. (2003) and Fujiki (2005) provide comprehensive surveys of the literature; Sibert (2006) and Vandenbussche (forthcoming) provide recent surveys over a related—and highly useful—social psychology literature that looks at the effects of group size on information processing and moderation.¹⁷

On the cost side, a plausible conjuncture is that larger MPCs will generally imply greater effort from all involved for a given decision problem. This may translate into less effective monetary policy making. The most important aspect is communication among members and the dynamics it creates. Even if the exchange of ideas at the preparatory stage of a decision were limited to a solitary statement by MPC members addressing their colleagues, larger MPCs would require more time than smaller MPCs in reaching a decision. Moreover, actual decision-making costs are likely to have a non-linear component. If MPC members regularly “sound each other out” during meetings (see, e.g., Barber 2001), the time requirement for preparing a decision will rise exponentially in the number of members (Berger 2006).¹⁸ Moreover, any advantages or benefits larger MPCs might have in comparison to smaller MPCs regarding the processing of information are likely to diminish at some larger level of membership.¹⁹

The view that increasing MPC membership size may reduce the effectiveness of policymaking is also bolstered by real-world experience. The German Bundesbank, for instance, asserts that its 1992 MPC reform triggered by German unification helped to prevent an increase in MPC size which “would have greatly complicated that body’s decision-making processes” (Deutsche Bundesbank 1992, p. 50).²⁰ More recently, the ECB (2003, p. 83) has expressed the fear that the anticipated increase in the number of national central bank governors attending euro area MPC meetings after EMU enlargement “will not necessarily make deliberations easier‥‥”

The trade-off between costs and benefits determining optimal MPC size will depend on a number of country characteristics. As Goodfriend (2005) has recently argued, larger and more heterogeneous currency areas may benefit from larger MPCs. This could be because of increased monitoring necessities or because a higher level of economic development gives rise to more complex monetary strategies, which may require larger decision-making bodies. Moreover, “[i]f an economy is complex, even if not particularly large geographically, then it might be useful to have the views of the key sectors represented on the policy committee” (ibid., p.85). At the same time, the costs of larger MPCs are also likely to vary with the size of the economy; the size of MPCs is less relevant for the costs of decision-making in cases where the central bank runs monetary policy for a small, open, and highly integrated economy so that there is a priori little room for independent policy making in the first place. Similarly, decision-making costs may vary with the underlying cultural consensus or democratic structure, which, in turn, could be a function of country size or heterogeneity.²¹

We will discuss these and other relevant economic as well as institutional and political country characteristics in somewhat greater detail below. In sum, the MPC size will reflect the trade-off between the costs and benefits along a number of dimensions—and it is likely to vary across countries. Whether the actual size is the outcome of an altruistic social planner, a political process, or an autocratic ruler, it can be useful to illustrate the aggregated pros and cons in a simple model (Box).

B. Determinants of Monetary Policy Committee Size

The discussion so far suggests that, if the design of central bank boards is based on a trade-off between country-specific marginal costs and benefits and shaped by specific institutional and political factors, MPC size should be influenced by various country characteristics. In what follows, we present a number of relevant and empirically testable arguments along this line.

Country size and heterogeneity

Making the argument for the empirical analysis operational, it seems safe to assume that information processing requirements are a (positive) function of diversity and country size. For economies with complex structures, a large number of board members might be particularly useful, allowing a review in detail of the (often diverse) information from various sectors and regions. Moreover, it is often larger currency areas that host a more heterogeneous populace with diverging preferences and/or varying institutional and cultural backgrounds, possibly weighing on monetary policy.²² For instance, if larger countries tend to produce more federal political structures, these structures may easily translate into the presence of regional representatives in the MPC.²³ Moreover, larger countries may be more independent in their monetary policy, which may make having larger MPCs more worthwhile. As a result, we would expect that measures of country size such as land area or population are positively correlated with MPC size. Similarly, measures of a country’s cultural or political fragmentation may have a positive influence on the size of the MPC.

Box 1:

A Simple Illustration

Assuming the number of MPC members reflects both the benefits and costs discussed above, a reduced form of the complicated political process could be illustrated by a simple and almost trivial model.^1/ Assume that country i maximizes welfare, W_i,

\begin{matrix} W_{i} = B (x_{i}, n_{i}) - C (x_{i}, n_{i}) & (1) \end{matrix}

where C measures the costs associated with MPC size, n_i, and B are the benefits. As discussed above, a plausible conjecture is that, in addition to n_i, benefits and costs depend on a vector of country-specific characteristics, x_i. Note that x_i may influence costs and benefits in a different way depending on their functional forms. While we assume these functional forms to be similar across countries, the reduced form shown above reflect country specific factors.

Reflecting the idea that, as a rule, decision making costs will be increasing in the number of decision makers in the MPC, C shall be a strictly convex function in n_i, that is, C_ni > 0 and C_ni,ni > 0. As a consequence, marginal cost will be increasing in MPC size. Moreover, assume that B is increasing in n_i, perhaps because of advantages in information-processing in larger groups, but at a non-increasing rate (i.e., B_ni > 0 and B_ni,ni ≤ 0). The slope of both marginal benefits and marginal costs depends on the country characteristics x_i. Within this setup, the optimal size of the MPC_i, $n_{i}^{*}$ , fulfills the marginal condition

\begin{matrix} B_{ni} (x_{i}, n_{i}) = C_{ni} (x_{i}, n_{i}), & (2) \end{matrix}

where our assumptions guarantee that an interior solution exists. As a consequence, $n_{i}^{*}$ will depend on the set of country characteristics captured in x_i as well as the specific form of the underlying cost and benefit functions. Because any one element in x_i may influence MPC size through the benefit or cost side, the estimated impact could take any direction and may not necessarily be linear.^2/

^1/ The model ignores the complicated dynamics. One of the findings in Hermalin and Weisbach’s (2001) survey of corporate boards was that (page 33): “Boards of directors are an institution that has risen endogenously in response to the agency problems inherent in governing any organization.” Lybek and Morris (2004) suggests that the trend toward central bank independence in the 1980s, central bank transparency and accountability in the 1900s, and good central bank governance in this decade has, together with new monetary regimes like inflation targeting, changed the role of the governing bodies of central banks.^2/ For instance, assume that marginal benefits are independent of n_i, marginal costs are linear in n_i, and that x_i is a simple scalar, x_i. In this case, equation (2) would be b(x_i) =c n, with c being a positive constant and b_i a positive function of x_i. This implies that the optimal MPC size will be n_i* = b(x_i)/c, which can take any form depending on the functional form of b(x_i). For instance, if b(x_i) is concave, we should observe a concave relationship between x_i and MPC size. Ultimately, however, this is an empirical question.

Development and openness

Another group of empirically identifiable factors potentially affecting MPC size are the economy’s state of development and its degree of external openness. One conjecture regarding the link between the level of economic development and central bank organization would be that a more elaborate monetary policy framework, including perhaps a larger MPC, could be a positive function of the average income level in a country. More specifically, larger and more developed economies may be less inclined to opt for simple monetary rules (such as a fixed exchange rate) and introduce more complex frameworks such as forward-looking inflation targeting, which may require larger MPCs to manage.²⁴ Also, countries at higher income levels and with more developed financial markets will, as a rule, have a larger supply of well-educated staff and potential MPC members. This should loosen any possible constraint imposed on MPC size at lower income levels. Furthermore, more developed and dynamic financial markets will also often result in the monetary transmission mechanism changing more frequently; hence the need for more balanced information when adjusting the monetary policy instruments.

On openness, Romer (1993) has argued that economies more open to international trade are more sensitive to currency fluctuations; possibly linked to idiosyncratic monetary or fiscal policy surprises, the sensitivity should lead to a more disciplined economic policy overall.

However, if openness was indeed making the MPC’s life easier by imposing, for instance, greater discipline on fiscal policy, one could speculate that smaller MPCs are needed in more open economies. The same should hold, ceteris paribus, for economies characterized by a high correlation of the national business cycle with the world cycle.²⁵

Political institutions

A larger MPC may also have advantages for political economy reasons. Monetary policy rarely operates in a political vacuum—quite to the contrary—and the design of a central bank is likely to reflect this. For instance, as noted before, diversity in terms of language or culture may increase the attractiveness of a larger MPC, thereby allowing fuller representation of varying interests and increasing the likelihood of gaining political legitimacy. Along similar lines, more developed democratic institutions allow for greater diversity in opinion and preferences and, therefore, may be a factor in favor of a more sizable MPC.²⁶

Another potentially relevant argument from political economy is related to the incentive of governments to dominate monetary policy for fiscal reasons. At the extreme, this can lead to fiscal determinacy of the price level, where monetary policy is forced to fully accommodate excessive fiscal behavior, including financing quasi-fiscal activities, and to allow runaway inflation to deflate the level of public debt (see, e.g., Woodford 2003). At a less drastic level, government officials may put pressure on the MPC to ease monetary policy and thereby lower the interest burden for the public finances. To insulate monetary policy from these pressures, optimal central bank design would aim for a high degree of central bank independence in the sense of Rogoff (1985). Blinder (2006) suggests that larger MPCs may be less easily swayed by government influence.²⁷ As a consequence, we might observe a positive correlation between MPC size and measures of fiscal pressure. Similarly, under the assumption that such pressures are present, MPC size may be complemented by stricter limits on central bank financing of fiscal deficits.²⁸

Other central bank characteristics

Finally, if the membership size of the central bank board is part of a multidimensional process of central bank design that also involves other aspects of central bank organization, we may expect that other design choices are reflected in MPC size as well. Various aspects come to mind. For instance, with reference to the discussion above, there may be good reasons to suspect that central banks having the authority to prioritize their objectives and specify the target to pursue generally have larger MPCs. More generally, it may be the case that central banks that are more independent from government operate under larger MPCs.

Along similar lines, also the monetary policy strategy and the exchange rate regime in which a central bank operates may be relevant determinants of MPC size. In the case of a hardpegged exchange rate, decisions on changing interest rates (in line with the anchor currency) require less deliberation and forward-looking analysis than, for example, interest rate policy in a monetary policy regime under freely floating exchange rates. As a consequence, we may expect more flexible exchange rate regimes to be associated with larger-sized MPCs.

In addition, one may argue that there is a negative association between MPC size and the envisaged average term length of MPC members since smaller groups require longer terms to ensure continuity.²⁹ Alternatively, larger groups can suffer a higher fluctuation frequency at the individual level without endangering the independence of the MPC from the government (which is likely to be involved in nominating new members).³⁰

Another factor that might be relevant for MPC size is the number of central bank staff. A possible link between the two variables is that larger MPC size could be simply reflective of a larger number of functions performed by the central bank, which may require both more staff and a larger MPC if the MPC also performs other functions.³¹ Similarly, if the constraints stemming from the availability of well-educated personnel (see above) also influence staff size, we should expect MPC size and the number of central bank staff to be positively correlated as well. The central bank’s operating expenditures may be another proxy for the functions performed by the central bank. Finally, path dependencies (possibly captured by the age of the institution) may play a role, with younger institutions being plausibly characterized by (yet) smaller boards having more specific assignments.

C. Summing Up

We have discussed a number of potential hypotheses for the observed differences in MPC size across countries—hypotheses that, in principle, are open to empirical testing. The optimal MPC size will, in principle, equate marginal benefits and marginal costs of membership size, but also reflect the institutional and political framework in which central banks operate, all of which vary across countries. Accordingly, observed MPC size may vary systematically with a number of country characteristics. In particular, we would expect that MPC size:

increases with greater diversity and country size;
is larger at higher levels of development, but decreases with greater openness;
is larger in the presence of stronger democratic institutions;
is larger in the presence of higher public debt levels;
is larger in the presence of a floating exchange rate system; and
interacts systematically with other elements of central bank design, including the degree of central bank independence, monetary policy strategy, staff size and operating expenditures, and the term length of MPC members.

The relationship between any of these country characteristics and the number of MPC members may well be non-linear—a possibility that the empirical approach should allow for.

III. Empirical Analysis

Our empirical strategy is to examine the association between MPC size and country characteristics in a very general fashion. Instead of emphasizing a particular variable or method, we use a (large) number of alternative measures and a variety of simple econometric specifications to identify possible structural correlations in the data. At the same time, this approach helps to take account of (sometimes) severe data limitations. We begin this section by describing our data, and then turn to testing the relationships between MPC size and various country characteristics, including several other features of central bank design.

A. Data Description

At the heart of our data set is the MPC size data obtained from Lybek and Morris (2004). This publication surveys 101 central bank laws (covering 113 countries) at the end of 2003 and classifies the governance structure of central banks along various dimensions. Lybek and Morris distinguish between different types of central bank boards (policy boards, implementation boards, pure supervisory boards, and advisory bodies) depending on the type of autonomy. We use information on the most relevant and powerful central bank board, the “implementation board,” i.e., the body that decides whether to change monetary policy instruments to achieve a specified target. Lybek and Morris have grouped MPCs into size classes of three members so that we effectively use a board size index that takes the value of one if the MPC consists of 1–3 members, the value of two if there are 4–6 members, and so on.³² Figure 1 provides a histogram of our MPC size measure. The 84 countries included in our sample are listed in Appendix II.³³

It is important to note that in many cases implementation boards also perform other functions. For instance, an implementation board may also oversee the central bank, or it may make decisions regarding payment systems or banking supervision. This potentially introduces a bias against other explanatory variables in the sample. For instance, if more functions imply larger MPCs, and the allocation of additional functions is not random across the country sample, estimated coefficients may suffer from an unobserved variables bias. Ultimately, however, because we cannot directly control for it, this is an empirical issue.

Our data on country characteristics and central bank features come from a number of different sources. Most of the data on country characteristics are taken from Rose (2006), who has compiled a large and comprehensive data set of country attributes, including physical, cultural, economic, political, geographic, and social phenomena. To this data set, we add information on central bank features such as the term length of board members or the type of legal independence, the establishment year, staff size, and operational expenses of the central bank. This information is mainly obtained from Lybek and Morris (2004); other sources are the Morgan Stanley Central Bank Directory, Fry et al. (2000), and Ize (2006). Finally, we have compiled macroeconomic data (e.g., on a country’s fiscal position) from the International Monetary Fund’s International Financial Statistics.

We also use three different exchange rate regime classifications: the well-known de facto classifications from Levy-Yeyati and Sturzenegger (2005) and Reinhart and Rogoff (2004), and the de jure classification from the IMF (2003). Detailed sources for variables are tabulated in Appendix III. Appendix IV provides descriptive statistics.³⁴

B. Methodology

We now turn to the correlates of central bank board size. We estimate both simple bivariate models and models augmented with a few key controls. In particular, we estimate regressions of the form:

MPC = α + β x + γ Y + ε

where MPC is our ordered MPC or board size index, x is the variable of interest, Y is a set of control variables and ε is a well-behaved residual. Due to the discrete categorical nature of our dependent variable, we estimate our equation using ordered probit techniques.

C. Bivariate Results

Tables 1–5 present the benchmark estimation results. For each variable, we report three sets of estimates. The first column records the slope coefficients obtained from simple bivariate estimation; accompanying scatter plots (for most variables) are shown in Appendix V. In column 2, we report the results of an augmented regression, adding population and per capita income as controls.³⁵ Finally, the last column presents the bivarate results with the MPC size measure transformed into a binary index that takes the value of one if the MPC comprises more than six members and zero otherwise; these results are based on standard probit estimates. In practice, it turns out that all of our key findings are robust to this transformation of board size into small and large boards; this also suggests that our results are not sensitive to outliers.³⁶ In the following, we group variables along the lines of arguments outlined in the previous section.³⁷

Table 1.

Characterizing MPCs: Size