Doves, Hawks… and Pigeons: Why Central Bankers Favour Monetary Policy Inertia

By Donato Masciandaro, Professor of Economics, and Chair in Economics of Financial Regulation, Bocconi University. Originally published at VoxEU.

The discussion of the delayed lift-off in US monetary policy is just the latest episode in a long-lasting debate over the causes of inertia in monetary policy. This column approaches the issue by assuming that psychological drivers can influence the decisions of central bankers. Loss aversion is one source of behavioural bias which can explain delays in changing the stance of monetary policy, including the fear of lift-off after a recession.

“Too little, too late”, or “wait and see” are phrases that the media frequently use when observing the tendency for central banks to postpone and/or delay interest rate decisions. The recent behaviour of the Federal Reserve System (Fed) is paradigmatic.

In the aftermath of the severest recession since WWII, the Fed faces extraordinary challenges in designing and implementing monetary policy. The overall result has been massive monetary accommodation with interest rates close to zero, coupled with an exceptional expansion of the Fed’s balance sheet.  The Great Recession ended in June 2009, but seven years on, the Fed is still delaying the process of returning to normal. Expansionary monetary policy has been implemented long after the recession ended, raising questions over the drivers and consequences of monetary inertia – in this case, reluctance to leave the ultra-expansionary monetary status quo to start a policy of interest rate normalisation. 

But the discussion over the (delayed) lift-off in US monetary policy is just the latest episode in a long-lasting debate, namely, how can inertia in monetary policy be explained? In several cases over the last two decades, central banks have shown reluctance to leave the monetary status quo, raising questions over the rationale that can justify such a stance. As has been insightfully pointed out (Orphanides 2015), at least in the case of US monetary policy, a period of monetary inertia after the end of a recession is not uncommon. At the same time, cases of monetary inertia have been registered for some time after the end of an expansion; further, this inertial feature of central bank behaviour has been especially noted in the case of the Fed, but it has also characterised many other central banks (Goodhart 1996, 1998, Woodford 1999, 2003).  The bias towards the status quo has been recently highlighted focusing on the Bank of England’s Monetary Policy Committee (Barwell 2016).

So far, the economic literature has offered two different explanations: information inertia and governance inertia.

Originally, monetary inertia was explained by the observation that central bank decisions depend on information on the state of the economy, as well as on the recognition of the long and variable lags in the transmission of monetary policy. Monetary inertia can therefore be considered a rational strategy to avoid tough ‘stop-and-go’ policies and their consequences in terms of negative macroeconomic spillovers, and the tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions can thus be considered optimal (Woodford 1999, Driffil and Rotondi 2007, Consolo and Favero 2009). More recently, optimal monetary policy has been derived by departing from the rational expectations hypothesis, i.e. by assuming that individual agents follow adaptive learning (Mohnar and Santoro 2014).

Under a different perspective, the case of monetary policy inertia has been analysed by exploring the role of central bank governance. Two studies focusing on Monetary Policy Committees (MPCs) seem particularly interesting, namely, Dal Bo (2006) and Riboni and Ruge-Murcia (2010).

Dal Bo (2006) shows that a voting procedure that requires a supermajority (i.e. ‘consensus setting’) leads the monetary policy committee (MPC) to behave as a conservative central banker à la Rogoff (1985). The supermajority rule mitigates issues of time-inconsistency and introduces a status quo bias in monetary policy decisions.

 Riboni and Ruge-Murcia (2010) analyse four different frameworks in central banking governance: the simple majority (median voter) model, the consensus model, the agenda-setting model (where the chairman controls the board agenda), and the dictator model (the case of and influential chairman).

While the simple majority model and the dictator model are observationally equivalent to a one-man central bank, the consensus model and the agenda-setting model are different, creating something like a persistent status quo monetary policy. In the first two models, the MPC adjusts the interest rate taking into account the value preferred by the key members – the median voter and the chairman, respectively – regardless of the initial status quo. In the other two models, the MPC can keep the interest rate unchanged in the ‘inaction region’, i.e. monetary inertia can occur. Further, the agenda-setting model predicts larger interest rate increases than the consensus model when the chairman is more hawkish than the median member. In other words, inertia in interest rate decisions can be associated with features of central bank governance (governance inertia).

But now, what happens if we assume that psychological drivers can influence the decisions of the central bankers? In a recent paper, my co-author Carlo Favaretto and I simulated a monetary policy setting with three different kinds of central bankers (Favaretto and Masciandaro 2016).

The members of an MPC (i.e. central bankers) can be split into three groups – doves, pigeons, and hawks – depending on their monetary conservativeness. In the monetary policy literature, a specific jargon has been coined: a “dove” is a policymaker who likes to implement active monetary policies, including inflationary ones, while a “hawk” is a policymaker who dislikes them (Chappell et al.  1993, Jung 2013, Jung and Kiss 2012, Jung and Latsos 2014, Eijjfinger et al. 2013a, 2013b, Neuenkirch and Neumeier 2013, Wilson 2014, Eijffinger et al. 2015); “pigeons” fall in the middle. Throughout time, the dovish/hawkish attitude has become one of the main focuses of the analysis of monetary policy board decisions.

 The model introduces sequentially the assumptions that each central banker is a high-ranking bureaucrat – i.e. a career-concerned agent – with his/her conservativeness, that a monetary policy committee formulates monetary policy decisions by voting with a simple majority rule, and finally that loss aversion characterises the behaviour of the central bankers – i.e. for every monetary policy choice, losses loom larger than gains, and both are evaluated with respect to the status quo.

The framework shows that, given the three types of central bankers, the introduction of loss aversion in individual behaviour influences the monetary policy stance under three different, but convergent, points of view. First of all, a moderation effect can emerge, i.e. the number of pigeons increases.  At the same time, a hysteresis effect can also become relevant: both doves and hawks soften their stances. Finally, a smoothing effect tends to stabilise the number of pigeons. The three effects consistently trigger greater interest rate inertia, which is independent of both the existence of frictions and the absence or presence of certain features of central bank governance.

Loss aversion can explain delays and lags in changing the monetary policy stance, including the fear of lift-off after a recession. Needless to say, the behavioural motivation doesn’t rule out the other motivations already stressed in the literature.

The results shed light on the fact that central bankers are individuals who are subject to the same sources of behavioural bias that all individuals face. In the presence of behavioural bias, the outcome of different information sets and/or governance rules can be quite different with respect to the standard case.

In other words, central bankers can justify their lack of active choices using informational reasons (“we adopted a data-dependent strategy”) or governance drivers (“we need to reach a larger consensus”), but being both bureaucrats – i.e. career concerned players – and humans, other perspectives need to be explored, namely, that central bankers can act consistently with behavioural biases. This perspective also deserves attention when designing and implementing central bank governance rules.

In fact, governance rules are defined assuming the existence of a principal agent framework between citizens and central bankers as bureaucrats, where the bureaucrats are rational players. Therefore, the governance challenge is to design rules of the game that can produce optimal interest alignment between society and central bankers. But the less central bankers represent rational individuals in the traditional meaning, the more the design of governance procedures must take into account the possibility of behavioural bias. In other words, the simple assumption that central bankers are career-motivated players who care about prestige is not sufficient when behavioural biases – such as loss aversion – can emerge systematically. In calculating benefits and losses of different monetary policies, behavioural central bankers make choices that are quite different with respect to standard central bankers.

It is worth noting that loss aversion is just one source of behavioural bias. A cognitive psychology perspective can be usefully employed in understanding the intertemporal challenges embedded in monetary policy analysis.

See the original post for references.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. BecauseTradition

    Shorter? Independent central banks equal rule by men and not by law?

    Also, it should be obvious that the central bank should not create fiat at all except for its monetary sovereign*.

    But then what to do about high interest rates and liquidity crises? ans: equal fiat distributions to all citizens.

    But how to finance those distributions? ans: With negative to 0% yeilding sovereign debt**.

    But who will buy negative to 0% yeilding sovereign debt? ans: Those who would otherwise have to pay even more negative interest on fiat account balances at the Fed.

    But what about the non-rich? Should they pay negative interest too? ans: No, since SOME risk-free liquidity/savings is legitimate so an individual citizen exemption of up to, say, $250,000 US should accompany negative interest on reserves (NIOR).

    But won’t the banks try to pass on negative rates to non-rich depositors? Yes, but who needs banks anyway since all citizens should be allowed inherently risk-free accounts at the central bank itself?

    But what about the strength of the US dollar if it can no longer buy welfare proportional to wealth? ans: It’ll probably go down but that should increase US exports and increase jobs.

    * to avoid violating equal protection under the law in favor of the rich, i.e. asset owners.
    **to avoid welfare proportional to wealth.

  2. Sound of the Suburbs

    “Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.

    Irving Fisher used neoclassical economics and believed markets reached stable equilibriums.
    What could possibly go wrong?

    Inflating asset prices does not represent real wealth but does give a temporary wealth effect.

    Nearly eighty years later and everyone is under the spell of neoclassical economics and believes markets reach stable equilibriums again. Under the “Emperor’s New Clothes” of neo-liberalism sits an old and failed economics, neoclassical economics.

    The Central Bankers have been busy using QE to create another wealth effect and have been keeping stock markets high.

    The financial sector than leverages up this imaginary wealth by various means, in 2008 it used securities and complex financial instruments.

    James Rickards in Currency Wars gives some figures for the loss magnification of complex financial instruments/derivatives in 2008.

    Losses from sub-prime – less than $300 billion
    With derivative amplification – over $6 trillion

    Inflating the US housing market and leveraging this up does create a wealth effect but it’s only temporary. Leveraging up over-inflated asset prices is the zero times table as far as real wealth is concerned. It just magnifies profits on the upswing and losses on the downswing. It’s good for bonuses and not much else.

    The Central Banker’s wealth effect in stock markets has been leveraged up with ETF’s, a myriad of financial assets all reflecting the same underlying real assets that sit at over-inflated prices.

    It’s time to move on from the hocus pocus of the financial sector and concentrate on the real economy that generates real wealth that is not temporary.

    Hocus pocus – the wealth is there and then its gone, abracadabra.

    1929 – US (margin lending into US stocks)
    1989 – Japan, UK (real estate)
    1999 – US (margin lending into US stocks)
    2008 – US (real estate bubble leveraged up with derivatives for global contagion)
    2010 – Ireland (real estate)
    2012 – Spain (real estate)
    2015 – China (margin lending into Chinese stocks)

    1. Sound of the Suburbs

      Ben Bernanke could see no problems ahead in 2007 in the same way that Irving Fisher could see no problems ahead in 1929.

      Hardly surprising as they both used the same economics.

      After the 1929 crash, Irving Fisher was ridiculed and the belief in markets was shattered, collective sanity was restored. Neoclassical economics with its belief in stable equilibriums was dumped in favour of Keynesian thinking.

      In the 1970s, Keynesian ideas started to go wrong and for some reason they were replaced by the old failed ideas of neoclassical economics and its belief that markets reach stable equilibriums!

      Irving Fisher was ridiculed when the markets crashed and lost a great deal of money, he was determined to find out where he had gone wrong and in the 1930s came up with his theory of debt deflation.

      Ben Bernanke attributed it to a “black swan” and took no responsibility, today’s expert does not have to get things right or even know what they are doing.

      Irving Fisher looked at the debt inflated asset bubble after the 1929 crash and developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

      Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today. The theory is there outside the mainstream, but you can move on from 1920s economics even if they won’t.

      Steve Keen saw the private debt bubble inflating in 2005, this is reflected in the money supply.

      Everything is reflected in the money supply.

      The money supply is flat in the recession of the early 1990s.

      Then it really starts to take off as the boom gets going which rapidly morphs into the US housing boom, courtesy of Alan Greenspan’s loose monetary policy.

      When M3 gets closer to the vertical, the black swan is coming and you have a credit bubble on your hands (money = debt).

      1920s economics or something more recent?
      If you like “black swans” 1920s economics is a must.

  3. EoinW

    Instead of inertia, how about abolishing central banks? It’s simply empowering a special interest group(the financial class) with complete control over the entire economy. Should we be surprised when it doesn’t benefit the average person?

    How about setting interest rates at 5% permanently? The number is negotiable. The important thing would be a set rate, meaning money is not continuously devalued. Most important is that every citizen would be able to plan for the future because they’d know what the rate will be in the future. Isn’t that better than having insiders cashing in on every rate change while the general population pays the price?

    I’m sorry but a flexible interest rate, and the abuse it invites, makes a return to a gold standard inevitable. Just a question of when and how much pain people must suffer in the process.

  4. plantman

    Here’s what I don’t like about this article: The author looks for the “psychological drivers (that) influence the decisions of the central bankers.”

    Fine. Then he makes judgements based on studies “Two studies focusing on Monetary Policy Committees “.

    The reader is thus tricked into scratching his head wondering which study is more persuasive.

    But what if the results of Fed policy– that is, the fact that ” 97% of all GDP-income gains went to the wealthiest 1% households”– conflicts with either analysis suggesting that the Fed decides policy using entirely different criteria? In other words, what if the Fed is merely an agency that sets policy in a way that best serves its constituents, the rich and powerful? Then neither study is applicable, right?

    Isn’t that a more probable explanation of how the Fed really operates or does someone actually believe that the last 7 years of stagnant growth and massive wealth transferal has been a big mistake.

    The policy is no a mistake. The people who are the big winners are supposed to be the big winners. That’s how the policy works. The rest is public relations, much like this article is public relations.

  5. Kay

    Bocconni?! Didnt Mark Blyth mention this school of economics ,in his book and talk about austerity? IIRC they are the ones that came up with the economic foundations for austerity policies.

  6. Chauncey Gardiner

    Lovely post. Ascribing Fed monetary and interest rate policy to good faith cognitive bias and organizational structure is highly questionable in my opinion. The factors behind monetary policy decisions, including years of QE-ZIRP and prolonged periods of policy inertia that have perpetuated the effects of that policy, merit public education and broad discussion. Further, policy coordination of Western central banks through the BIS was not mentioned. Repeated debt-fueled asset bubbles, manipulations of financial markets, and the collapse of those bubbles that have so enormously benefited a small segment of society are no accident in my view.

    Of course, monetary policies are a subset of a broader policy mix of domestic fiscal austerity, engineered job losses, wage suppression, tax and environmental forbearances, and free passes for criminal law violations for control and securities frauds that have so damaged the U.S. middle class and concentrated the nation’s wealth in the hands of a few individuals.

    I recall that various senior Fed officials have in the past said that they intended to begin raising interest rates at least as far back as 2012. I have concluded that either they are very poor economic predictors or they are complicit in keeping the deer frozen in the headlights. Inertia indeed.

  7. ChrisAtRU

    Of course, monetary policies are a subset of a broader policy mix of domestic fiscal austerity, engineered job losses, wage suppression, tax and environmental forbearances, and free passes for criminal law violations for control and securities frauds that have so damaged the U.S. middle class and concentrated the nation’s wealth in the hands of a few individuals.

    Brilliantly stated. Concur.

  8. larry silber

    Central banks act as a modern version of the Vatican, that colorful deceitful conduit of power and networking quaterbacking during the middle ages. Lulling people to sleep with pointless babble while obfuscating truths ,while sounding intelectually intimidating, was obviously a lesson well learned from history’s ashtray. Those that follow the workings of our Federal Reserve serve the institutions biddings incredibly well. Instead of pointing out the obvious simple truth, that our central bank is nothing more than a giant excell spread sheet, detailing and regulating the users of digital points in our American financial system , they preserve the mystique of economic geniuses tirelessly and unpolitically balancing our fragile, natural, and existential economy into some fantasy of dynamic equilibrium that cant be nudged too forcefully for fear of that unholy incarnation labeled hyper inflation. This essay questions the personality quirks of career minded ass kissers. Maybe interesting, but probably common sense. We need to figure how to get a politically independent central bank more in tune with average workers and less inclined to serve the financial interests of those who’ve already succeeded beyond their wildest dreams. Maybe it is impossible because this subject matter is so damn dry. I might not be the sharpest, but following that thread was sort of painful. Much was conveyed, probably meaningful, but if i hadn’t the background of MMT to put things in propper context, I would have walked away affirming my misunderstanding of how mysterious and complex the inner workings of the Fed are. The distractions from the Ron Paul view would hit home, and I’d be railing to end what appears to be controlled and run by politically motivated out of touch elites. Certainly from that point crazy Ron is correct. That they’re missing any sense of empathy or compassion, along with personality or passion, seems to be a necessarry ingredient in central bankers.
    This country can solve many of its problems quickly and easily, but because of ignorance from misdirection and disinformation the future looks like mayhem from the frustrations inherent inequality.

  9. AngloSaxon

    This post is lagging wrong. We indeed now are returning to normal. Gonna be fun to watch nostrils flare next year as normalization continues on.

  10. Spencer

    There’s no inertia. Between 1942 and Oct. 2008, the DFIs responded immediately to any injection of liquidity. However, remunerating IBDDs emasculated the Fed’s “open market power”.

    This is an example BuB’s error:

    “Regulation Q, which capped interest rates payable on deposits, prevented banks from offsetting the decline in deposits by offering higher interest rates”

    The 1966 S&L credit crunch is the economic paradigm. BuB doesn’t know the difference between money and liquid assets. BuB caused the GR all by himself.

  11. Alanna Hartzok

    No mention of seignorage reform ala American Monetary Institute and the bill that Congressman Dennis Kucinich pushed for a few years ago. Why not consider banking to be public infrastructure run on a no profit no loss basis? Issue money for social spending, not debt?

  12. Scott

    Larry & Alanna are more correct. When designing another government we determined that bureaucrats needed to be given a career path towards status as technocrats.
    Glass Steagall was a technocratic solution to the capitalistic banking system. That power has no interest in reinstitution of that shows business as usual is to be unusual as all savings of the not rich enough are to be gambled away before it can be passed on to their children.
    Since the Financial Terrorists and parasites were protected by Clinton, Bush, & Obama, and the currency is claimed to be Fiat as a Reserve currency that means the more ridiculous European Banking of the Euro EU continues to make US Currency more stable because the US has more of an army.
    So then, war will be next because the F-35 flys.

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