It has been argued that the institutional set-up for monetary and macroprudential policy in the UK is in need of reform (see Turner (2022) and Allen (2022)). Rather than having two policy committees, some commentators argue that it would be better to give control over both sets of policy levers to just one committee (see also Breeden (2023) for a defence of the status quo). This blog will discuss the merits of unification, and conclude that the arguments are not compelling. In short, it is unclear to us what practical (as opposed to hypothetical) problem merging the two committees would resolve.

Author: Professor David Aikman and Dr Richard Barwell

Published: 23 March 2023

Unification versus delegation: is one policy committee better than two?

It has been argued that the institutional set-up for monetary and macroprudential policy in the UK is in need of reform (see Turner (2022) and Allen (2022)). Rather than having two policy committees, some commentators argue that it would be better to give control over both sets of policy levers to just one committee (see also Breeden (2023) for a defence of the status quo). This blog will discuss the merits of unification, and conclude that the arguments are not compelling. In short, it is unclear to us what practical (as opposed to hypothetical) problem merging the two committees would resolve.

White and Gray Control Panel by Şahin Sezer Dinçer / Pexels

White and Gray Control Panel by Şahin Sezer Dinçer / Pexels

The superficially decentralised institutional design of macroeconomic policy in the UK

The design of macroeconomic policymaking in the United Kingdom – or at least macroeconomic policy run out of the central bank – conforms to an institutional analogue of the Tinbergen principle: for every policy sphere there is a separate policy committee. We have a Monetary Policy Committee (MPC) responsible for monetary policy and a Financial Policy Committee (FPC) responsible for macroprudential policy.

First impressions can be deceiving. The institutional structure is less decentralised than it appears. Four people – the Governor and three Deputy Governors (for Monetary Policy, Financial Stability and Markets & Banking) – feature on both committees. If we include the Executive Directors and the Deputy Governor for Prudential Regulation (who sits on the FPC) then Bank ‘insiders’ represent a majority on both committees. So whether decisions are taken by majority rule (MPC) or by consensus (FPC) the insider influence on both committees is unquestionably significant. Indeed, when it comes to decisions which influence the risk profile of the Bank’s balance sheet, which could be the case for both monetary and macroprudential interventions, decision-making power has been delegated by Court to the Bank’s Executive rather than the committees.  Moreover, both committees rely on the Bank staff for analytical support, which further entrenches the influence of the internals (to whom the staff report) on decision-making.

The case for unification – putting macroprudential policy in the hands of the MPC

One argument for centralising decision-making within one committee is that it manages the risk of very bad outcomes in circumstances where monetary and macroprudential policy are acting at crossed purposes.

The Tinbergen principle essentially states that we need as least as many instruments as we have targets. It doesn’t say that we need as least as many committees as we have targets.

A simple, albeit extreme, starting point is where these policy regimes are orthogonal to one another – that is, adjusting one instrument to achieve the relevant target has no implications for policy choices in the other regimes.  In this case we can unpack a multidimensional policy problem of N targets and at least N policy instruments into N separate unidimensional policy problems.  If we ignore the practical constraints for a second (that we shall go on to discuss), it should make no difference to outcomes whether the N policy problems are tackled by a single committee or N separate committees.

This orthogonality condition will rarely apply in macroeconomic policy and certainly not in the case of monetary and financial stability. Indeed, one (controversial) visualisation of the respective roles of monetary and macroprudential policy is that they both try to influence the distribution of future macro outcomes, only different moments and perhaps at different horizons. That is, monetary policy seeks to move the first moment – the location – of that distribution (towards growth at trend and inflation at target), over the next couple of years, whilst macroprudential policy seeks to influence the second and third moments – the variance and the downside skew – of that distribution (reducing the risk of very bad outcomes) at perhaps longer horizons. But even if one rejects that controversial characterisation one must concede that outcomes and policy interventions in one sphere will influence the conduct of policy in the other. At this point ownership of the instruments ceases to be a matter of no importance because it will determine how the system is controlled.

There are three specific causes for concern in the context of our discussion about the MPC and FPC.

  1. Circumstances where monetary and macroprudential policy might pull in opposite directions. For example, rapid growth in credit might lead the FPC to tighten macroprudential policy which might then slow demand, leading the MPC to ease monetary policy which might somewhat undermine the FPC’s initial intervention, leading to a further tightening by the FPC and so on. Uncoordinated decision-making might lead to more extreme instrument settings in these circumstances, which might be considered to carry a welfare cost (although likely not a first order one), but both committees should still be able to achieve their goals.
  2. Circumstances where the one or both policymakers face constraints on the use of instruments which can prevent the pursuit of goals. For example, if there is a lower bound on the effectiveness of rate cuts and an upper bound on the effectiveness of asset purchases, then decisions by the FPC which dampen demand can have a detrimental impact on the pursuit of price stability, once monetary policy is in the vicinity of those constraints because the MPC is powerless to respond (this is the flip side of the argument that expansionary fiscal policy is highly effective in the vicinity of those constraints).
  3. Circumstances where the objectives of the two regimes are incompatible in the medium-term. For example, it has been argued that consistently delivering low inflation and stable growth can sow the seeds of future financial instability by encouraging excessive risk-taking.

How these circumstances are resolved in the decentralised (multi-policymaker) set-up will depend on the mode of communication and collaboration between the policymakers. One can imagine a world of intense collaboration which converges upon the single policymaker set-up. Or one can imagine a world in which these is no communication, let alone coordination, and the two policymakers move sequentially, playing best response to one another.  One can even imagine a Stackelberg-type set-up where one policymaker (‘the leader’) can credibly commit to stick to a particular course of action – perhaps because she sets policy on an infrequent basis – and the other policymaker (‘the follower’) accommodates her, setting policy on the basis that the stance of policy in the leading sphere will not change.

To be clear, these problems are not resolved by centralising power with one committee: the spillovers between regimes, the proximity of constraints, and the tensions between goals must still be managed. However, a type of robust control argument can be made that centralising power reduces the risk of very bad outcomes that might arise in truly dysfunctional set-ups with multiple committees and zero coordination, which the politicians (to whom both committees are accountable) are somehow unable to resolve.

The other argument for coordination is that a single committee would be better placed to ‘connect the dots’.  In his evidence to Congress, the Director of National Intelligence, Michael McConnell, argued that 9/11 could have been prevented if only the system had been able to connect information that was available.  What has this got to do with macroeconomic policy? One could argue that the real challenge in macro policy is to estimate your model of the system and identify the shocks as best and as fast as you can – the rest is just a policy calibration exercise (what is the right response given the shocks and the system). Once you accept that monetary and macroprudential policy are not orthogonal then you appreciate that the model estimation and shock identification tasks are a somewhat shared endeavour.

The ‘connect the dots’ argument says that a single policy committee that has to engage with both the monetary and macroprudential agendas would stand a better chance of understanding how the macro-financial system behaves and the true nature of the shocks hitting that system and hence the likely evolution of the system than two committees looking at only a subset of the data. It follows that the policy instruments would be set in a superior way by the single committee than two committees who have each misdiagnosed the problem.

The same argument could be applied to the staff that support these committees. Indeed, perhaps it is even more powerful at this level. Rather than having two separate teams both monitoring, say, the UK household sector for the purposes of the FPC and MPC, it make more sense to have one team that is charged with thinking about how developments in that sector influence both monetary and financial stability.

How relevant either of these arguments are when applied to the MPC and FPC is at best unclear.

After all, as we noted above, four of the Bank’s Governors sit on both committees and ‘internals’ are the majority in both, the two committees do work with each other (they sometimes share meetings) and they are supported by staff from the same institution.  There is an explicit reference to interactions between monetary and macroprudential policy in the FPC’s remit, in which the FPC is obliged to describe how it has had regard to the policy settings and forecasts of the MPC in order to enhance coordination between the committees in moments where their short-term objectives might not be aligned. The chances of the relationship between the MPC and FPC becoming truly dysfunctional look pretty remote. Likewise, the common Governors and the links between the staff that serves those committees should help the Bank to connect the dots even without a single policy committee.

Indeed, far from a dysfunctional relationship between the committees, one can point to a real-world example of the FPC taking concrete action to simplify the task of the MPC.  The FPC’s intervention in the mortgage market had much less to do with heading off a near-term risk to financial stability and much more to do with managing one of the risks highlighted above, namely that monetary policymakers might find themselves constrained in a future recession. The FPC acted because it believed that if the UK household sector became too highly indebted then it would likely respond disproportionately to future income or interest rate shocks, significantly cutting back spending and that would lead to economic instability – presumably because there was insufficient scope to ease monetary policy and stimulate demand. This is not to say that the mortgage market intervention was a mistake. Simply, that the current arrangements have demonstrated a considerable amount of flexibility.

Reasons for preserving the status quo

One key argument for preserving the status quo is that the overlap between the two policy regimes is smaller than macroeconomists pretend.

Contrary to what you might have heard, macroprudential policy is not smoothing the credit cycle by another name. It is true that the macroprudential perspective on financial stability relates to the preservation of an adequate supply of core financial services to the real economy by the financial system across almost all states of the world. If a financial crisis leads to a credit crunch then that would likely represent a failure of macroprudential policy even if no systemically important institutions fail (note: we emphasise almost all and likely because it seems unlikely that any macroprudential policymaker would be asked to implement a zero failure regime, to build sufficient resilience in the system such that it can withstand and continue to supply core services even in the face of the most extreme shock imaginable). However, this should not be confused with a policy of trying to influence the terms on which credit is supplied, both on a cyclical (leaning against boom and bust in broad credit conditions) or structural basis (an industrial policy of leaning against perceived mis-pricing in certain segments of credit markets).

Instead, macroprudential policy is very much about monitoring and managing risks to the resilience of the financial system.  The macroprudential policymaker will have a keen interest in: the state of balance sheets within the financial system on both sides of the regulatory perimeter; the contractual and behavioural connections between institutions and markets within the financial system; and developments in a broad range of wholesale and retail markets. Only a subset of these issues will feature in the conventional briefing and models that monetary policymakers rely on. Even when it comes to the macroprudential analysis of real economy agents (households and companies) there is a focus on outcomes within the distribution (e.g., the incidence of arrears and negative equity in the population of mortgagors) that is not typically of first order importance to the conduct of monetary policy. Beyond these questions which speak to the current cyclical position of the macro-financial system, there is a whole series of structural issues on the macroprudential agenda, like cyber risk or resolution plans, which will have little to no salience for monetary policymakers.

The smaller the overlap between the monetary and macroprudential policy agendas, the smaller the case for centralisation of power within one committee. Moreover, practical arguments for preserving decentralisation become more powerful. To fix ideas, we can split the macroprudential agenda into two sets of issues: a cyclical component where the data and the issues would be broadly familiar and relevant to the MPC; and a structural component where it is less so.  Clearly, it is much easier for MPC members and MPC meetings to digest the first set of issues than the second. However, the second set of issues cannot be neglected and that has knock-on implications however the workload is managed.

If the MPC is going to be responsible for the structural aspects of the FPC’s agenda then the MPC will need to digest a lot more material, sit through more policy meetings and agree and communicate more decisions. One might wonder whether there is a risk of overload here. There are also questions about the membership of the MPC. Ideally all MPC members – and at the very least, the large majority of members – would now need to have experience, expertise and interest in both macro (monetary) and structural prudential issues. Identifying a sufficient number of high quality candidates that not only have that broad skillset but also deliver a diverse committee would not be straightforward.

Alternatively, the structural agenda of the FPC could be passed to the PRC.  We should be clear about what this means: it would essentially unwind the post-crisis reforms and return to a model of a macroeconomic policymaker (the MPC) and a prudential policymaker (the PRC). We view this as a non-starter and do not discuss this idea further here. However, even if this were deemed to be a good idea, it would lead to the same set of issues discussed above: increased workload and revised membership of the PRC as it absorbed new ‘macro’ functions.

One clear risk with merging the MPC and FPC is that the macroprudential issues gradually slip down (and ultimately off) the MPC’s agenda, supplanted by the latest issue in the monetary policy sphere.  This might happen by accident given the relative frequency of the two policy debates or the relative clarity of the two policy objectives. It is in the very nature of risks to financial stability that they will tend to build gradually. In contrast, there is always something to discuss in the monetary policy sphere. Nor is there the equivalent of the monthly inflation data that could provide a regular update on whether the financial stability objective is being achieved.  In short, macroprudential discussions will tend to have a more repetitive feel than monetary policy discussions – with little change from one quarter to the next – and most of the time there will not appear to be any significant financial stability problems on the horizon. The lack of external scrutiny of macroprudential issues – by academics, market participants, journalists and politicians – in these periods of tranquillity adds to this problem: there is no external prompt forcing the MPC to re-focus on macroprudential issues.

The uncertainty over the macroprudential framework is arguably of greater concern. We discussed above how a centralised committee can internalise the potential tensions between the pursuit of two inter-dependent objectives given sufficient instruments. The problem comes when only one of the two objectives is clear. The objectives, conduct and performance of monetary policy are all well understood. Everybody knows the target the MPC is trying to achieve, there is broad agreement on what success and failure look like and how the MPC should adjust policy instruments to achieve its objectives and whether it is currently doing so.  This is not the case with macroprudential policy.  Thinking back to the literature on optimal contracts for central bankers (Walsh (1995)), it is not hard to see problems arising when policymakers are asked to execute two policy functions, when there are trade-offs between the pursuit of those two goals but success or failure is much easier to evaluate on one regime than the other (on this point, see also Broadbent (2018)).

An international perspective

It is useful to bring international experience to bear on this issue of whether one unified committee is preferable to two separate bodies. A range of different decision-making models exist for setting macroprudential and monetary policies: at one extreme, there are countries with a single committee with decision-making powers over both monetary and macroprudential policy; at the other, we have countries where these powers are vested in entirely distinct organisations.  There are also cases in between, including the UK’s model of clearly delineated committees with legislative mandates for monetary and macroprudential policy, albeit residing with the central bank.

There is essentially no correlation between these decision-making structures and how active countries have been in macroprudential policy.  The table below lists (in order) the 10 most macroprudentially-active countries since 2010 (Source: IMF’s iMaaP database).  Countries in the ‘1’ category we think are best described as having a single body with responsibility for monetary and macroprudential policy; those in the ‘2’ category are better thought of as having separate decision-making structures.  Evidently, activism is not well explained solely by organisational structure and other factors (e.g., the severity of recent crises) must be at work.

Table:  Top 10 most macroprudentially-active countries according to IMF

 Country  Monetary and financial  policy set by ….  

1 = monetary and financial  policy set by single body

2 = monetary and financial  policy set by separate  committees

 Details 
 Hong Kong  1 Central bank (HKMA) sets  macroprudential and monetary  policy
 Singapore  1 Central bank (MAS) sets  macroprudential and monetary  policy
 Korea  2 The financial regulator (Financial  Services Commission) sets  macroprudential policy; the Bank of  Korea sets monetary policy
 Canada  2 CCyB and stress test set by financial  regulator (OSFI); LTV set by MoF;  monetary policy by BoC
 Israel  1 Monetary Committee of the Bank of  Israel sets both monetary and  macroprudential policy
 Norway  1 Monetary and macroprudential  policy set by Norges Bank’s  Monetary  Policy and Financial  Stability  Committee
 Netherlands  2 Macroprudential policies set by DNB  and MoF (LTV); monetary policy set  by ECB
 New Zealand  2 Monetary policy set by MPC;   macroprudential policy set by the  RBNZ’s Governing Committee
 Slovak Rep  2 CCyB and stress test set by the  central bank; LTVs set by the MoF;  monetary policy by the ECB
 UK  2 FPC sets macroprudential  policy; MPC sets monetary policy

Notes:  Data on macroprudential activism is from the IMF’s iMaaP database.  Information on decision-making structure is from Correa, Edge and Liang (2017) and from central bank websites.

Conclusions

On balance, we find the arguments for preserving the status quo more persuasive. The risk of the relationship between the FPC and MPC turning dysfunctional looks remote to us, so we attach little value to the insurance policy of centralising power within one committee. We do not believe that a unified model cannot work. Clearly, the international evidence suggests that single committees can effectively execute monetary and macroprudential responsibilities. However, there remains a couple of reasonable concerns about the unified model: that some of the more structural aspects of the macroprudential agenda could all too easily slip off the radar of an over-worked single committee and that the membership of the committee could drift towards individuals with macroeconomic expertise and experience to the detriment of decision-making on some macroprudential issues.

References

Allen, W (2022), ‘Models of central banking and the organisation of the Bank of England’, NIESR Policy Paper 38.
Breeden, S (2023), ‘Two sides of the same coin’, Speech.
Broadbent, B (2018), ‘Monetary and macroprudential policies’, Speech.
Correa, R, Edge, R and Liang, N (2017), ‘A new dataset of macroprudential policy governance structures’ , FRB International Finance Discussion Papers Notes.
Turner, P (2022), ‘Interest rate risk, monetary policy and the threat of financial crisis’, Macroprudential Matters.
Walsh, C (1995), ‘Optimal contracts for central bankers’, American Economic Review, 85(1), pp. 150-167.