The Dynamic (In)efficiency of Monetary Policy by Committee

Abstract

This paper develops a model where the value of the monetary policy instrument is selected by a heterogenous committee engaged in a dynamic voting game. Committee members differ in their institutional power and, in certain states of nature, they also differ in their preferred instrument value. Preference heterogeneity and concern for the future interact to generate decisions that are dynamically inefficient and inertial around the previously-agreed instrument value. This model endogenously generates autocorrelation in the policy variable and helps explain the empirical observation that the distribution of actual interest rate changes has a mode of zero.

Keywords: status-quo bias, policy conservatism, policy inertia, gridlock interval, interest-rate smoothing

JEL Classification: E4, E5, D7