Working Paper: CEPR ID: DP8143
Authors: Michael Ehrmann; Marcel Fratzscher
Abstract: How and why do politicians? preferences about monetary policy differ from the interest rates set by independent central banks? Looking at the European Central Bank, the paper shows that politicians, on average, favor significantly lower interest rates. Three factors explain the different preferences. First, politicians put relatively less weight on inflation (and more on output) in their preferred monetary policy reaction function. Second, politicians? preferences are affected by political economy motives. Third, different preferences are also, and largely, due to different constituencies, as politicians primarily focus on national economic objectives rather than the euro area as a whole.
Keywords: Delegation; European Central Bank; Interest Rates; Monetary Policy; Time Inconsistency
JEL Codes: D72; D73; E43; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| politicians' preferences (D72) | lower interest rates (E43) |
| political economy motives (P19) | politicians' preferences (D72) |
| weak national economic performance (F52) | politicians' preferences (D72) |
| low public trust in the ECB (E58) | politicians' preferences (D72) |
| electoral pressure (D72) | politicians' preferences (D72) |
| high public debts or deficits (H68) | politicians' preferences (D72) |
| political commentary (D72) | perceived monetary policy stance (E52) |
| politicians' preferences (D72) | gap between actual rates and preferred rates (E43) |
| political motives (D72) | gap between actual rates and preferred rates (E43) |