T H E D E C I S I O N S O F T H ES H A D O W M O N E T A R Y P O L I C YC O M M I T T E E A N D M O N E T A R YP O L I C Y C O M M I T T E ES I N C E 2 0 0 2 ecaf_2163 91..93

Jahyun Koo, Ivan Paya and David A. Peel

We analyse the decisions of the Monetary Policy Committee (MPC) and therecommendations of the Shadow Monetary Policy Committee (SMPC) over theperiod 2002–2011. We find that the SMPC policy recommendations have to a largeextent agreed with the policy actions of the MPC on interest rates. We offer somesuggestions as to how the recommendations of the SMPC could be enhanced.

Keywords: Monetary Policy Committee, Shadow Monetary Policy Committee,

governance, interest rate smoothing.

The inaugural meeting of the ShadowMonetary Policy Committee1 (SMPC) was heldin July 1997 immediately after the Bank ofEngland Monetary Policy Committee (MPC)was established. The meetings have been heldonce a quarter2 and the decisions and minutesof the SMPC are published a few days beforethe Bank of England’s own interest ratedecision each month. The SMPC’sdeliberations and decisions are coveredregularly in newspapers such as the TheSunday Times and, formerly, The Business andother leading newspapers. We thought itworthwhile to examine the relationshipbetween the decisions of the MPC and theSMPC concerning interest rates.3

Although the SMPC is not attempting toforecast the decisions of the MPC, if thedecisions were unrelated it would raise issuesabout the credibility of either or both of thegroups. In fact the SMPC consensus policyrecommendation agreed with the MPC policydecision on 72 out of 90 occasions over theperiod January 2002 up to November 2011.These are detailed in Table 1.

We observe that in this period the MPChas made the decision to hold 70 times ofwhich the SMPC made the same decision 59

times. The MPC decided to raise nine times ofwhich the SMPC made the same decisionseven times. The MPC decided to cut on 11

occasions whereas the SMPC made the same

decision on six occasions.4 This recordsuggests there is some significant informationcontent in the SMPC recommendation as aguide to the likely decision of the MPC. Inaddition when disagreements occur the SMPCtends to be more hawkish (14 out of 18

occasions when there has been adisagreement) than the MPC.

However there is some evidence that theSMPC may advocate policy changes morefrequently than is desirable from theperspective of interest rate smoothing. Thistheoretical idea suggests that central banksshould adjust interest rates gradually inresponse to changes in economic conditions.In certain economic models this has virtuousimplications owing to the way it steersprivate-sector expectations of future policy(see, for example, Woodford, 2003).

For instance in Table 2 we consider thedecisions of the MPC and therecommendations of the SMPC over theperiod January 2011 to November 2011. Row(a) is the MPC decision and row (c) is theSMPC decision. As we observe in Table 2, theMPC has kept interest rates fixed over thisperiod at 0.5 %, whilst the SMPC hasadvocated an interest rate increase to 1% sixtimes and hold at 0.5% five times. However inApril, July and October the SMPC has agreedwith the hold decision of the MPC in themonth following their previous

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© 2012 The Authors. Economic Affairs © 2012 Institute of Economic Affairs. Published by Blackwell Publishing, Oxford

recommendation to increase rates, in other words reversing itsown decision of the previous month.5

Row (d) labelled DSMPC sets out the implications of theSMPC suggested policy action in a given month relative totheir previous interest rate recommendation. For instance, inApril 2011 the value of -0.5 tells us that the SMPC decision ofkeeping rates at 0.5 implies a cut of -0.5 relative to theirprevious decision. This follows since according to theirprevious recommendations interest rates should be at 1% giventhey suggested a 0.5% increase in February and recommendedholding rates at 1% in March. In fact for twelve of the eighteenoccasions that the SMPC has disagreed with the MPC decision,their recommendation in the following month has been areversal of their previous month’s recommendation to nowagree with the policy stance of the MPC.

Though this analysis is suggestive that the SMPC decisionsare possibly too volatile, we acknowledge that, because theSMPC decisions are not actually implemented, this mayinduce more volatility (that is less smoothing) into the SMPCdecisions as the path of inflation or output would not followtheir ‘predicted’ path. There may also, of course, have beennew information over the month that leads them to a changeddecision. The rationale when they reverse their own policyrecommendation of the previous month is not currentlyprovided.

It is also of interest to compare the decisions of the MPCand SMPC in the first crisis period from November 2007 toApril 2009. This is set out in Table 3. The SMPC acted aheadof the MPC (07.12) in recommending initial drops in rates dueto concerns about uncertainties created by credit crunch.

However, it was in line with the MPC during 2008 and sinceNovember 2008 the SMPC was less aggressive in its stancetowards lower rates, with differences up to one percentagepoint (08.11), and lagged behind the MPC’s subsequent dropsuntil it eventually came into line in April 2009.

We conclude from this analysis that the SMPC policyrecommendations have to a large extent agreed with the policyactions of the MPC on interest rates. When policydisagreements have occurred on the interest rate stance, theSMPC has typically reversed its previous, ‘hawkish’ decision tocome into line with the MPC’s actions. The SMPC may havebeen slow to recommend interest rate cuts in the crisis periodof end of 2008-beginning of 2009. The SMPC’s decisions tendto be more variable than the MPC’s, perhaps due to issues ofgovernance.

The SMPC includes economists who have internationalreputations as academics per se, members who are significantplayers in the practitioner community and those who haveacted as advisors to governments. Having such a forum toprovide timely comment on the policy stance of the MPC, aswell as their own recommendations, is surely a valuable inputinto the policy debate. We would suggest that the informationcontent of their views could be enhanced if the SMPC movedto a more stable core of voting members. We would alsosuggest that the SMPC should provide explicit commentarywhen policy recommendations are reversed from the previousmonth as well as explicit votes about quantitative easing.

1. The decisions and minutes of the SMPC have been available since 2002 onthe website of the Institute of Economic Affairs, www.iea.org.uk.

Table 1: MPC decisions and SMPC agreements

PolicyMPCdecisions

SMPC recommendations

Agreements

Disagreements

Sub total hold cut raise

Hold 70 59 11 – 2 9Cut 11 6 5 5 – –Raise 9 7 2 2 – –Total 90 72 18 7 2 9

Table 2: MPC decisions and SMPC recommendations, January – November 2011

11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11

(a) MPC 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5(b) change 0 0 0 0 0 0 0 0 0 0 0(c) SMPC 0.5 0.5 → 1.0 0.5 → 1.0 0.5 0.5 → 1.0 0.5 → 1.0 0.5 0.5 → 1.0 0.5 → 1.0 0.5 0.5(d) DSMPC 0 +0.5 0 -0.5 +0.5 0 -0.5 +0.5 0 -0.5 0

Table 3: MPC decisions and SMPC recommendations from November 2007 to April 2009

07.11 07.12 08.1 08.2 08.3 08.4 08.5–08.9

(a) MPC 5.75 5.50 5.50 5.25 5.25 5.00 5.00(b) change 0 -0.25 0 -0.25 0 -0.25 0(c) SMPC 5.75 → 5.75 5.75 → 5.25 5.50 → 5.25 5.50 → 5.25 5.25 → 5.25 5.25 → 5.00 5.00 → 5.00(d) DSMPC 0 -0.50 0 0 0 -0.25 0

08.10 08.11 08.12 09.1 09.2 09.3 09.4(a) MPC 4.50 3.00 2.00 1.50 1.00 0.50 0.50(b) change -0.5 -1.5 -1.0 -0.5 -0.5 -0.5 0(c) SMPC 5.00 → 4.50 4.50 → 4.00 3.00 → 2.00 2.00 → 2.00 1.50 → 1.50 1.00 → 1.00 0.50 → 0.50(d) DSMPC -0.5 -0.5 -2.0 0 -0.5 -0.5 -0.5

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© 2012 The Authors. Economic Affairs © 2012 Institute of Economic Affairs. Published by Blackwell Publishing, Oxford

2. Monthly decisions and minutes of the SMPC are available since August 2005through the email surveys in between the months of formal SMPC meetings.

3. MPC members have voted explicitly on both the appropriate level of BankRate and the amount of asset purchases it judges necessary to meet theinflation target from March 2009. The SMPC members express their viewabout Quantitative Easing (QE) within their ‘Bias’ in their vote about BankRate (often with no mention of QE). Consequently we do not consider indetail the recommendations on QE here. However we would note that theSMPC advocated the adoption of QE, at least as early as the MPC, and waseven ahead of its extension during 2009 and 2010. For instance all ninevoting members were in favour of QE in April 2009 and there weremembers advocating QE in January 2009. However, during mid-to-late 2011the SMPC was not so much in favour in additional QE (mixed withsuggestions of an increase in rates on six occasions). Considering that theinstrument of monetary policy shifted towards the quantity of moneyprovided rather than its price (Bank Rate), perhaps the SMPC should bemore explicit about its policy on QE and hold an explicit vote.

4. Statistical analysis using the multilogit method suggests the SMPC policydecision is not significantly correlated with the MPC decision to cut interestrates over this period. In other words it is on average more ‘hawkish’.

5. This possibly ‘non-optimal behaviour’ may be due to the form of‘governance’ of the SMPC. For some time it has constituted more members,

currently 16, than are allowed to cast votes, which is 9. Those allowed tovote are decided on a first-come-first-served basis, for example the first ninearriving at the meeting. Consequently the identity of voters making up theSMPC consensus has often changed by three-to-four per meeting. Inaddition there are now four members on the SMPC from one universitydepartment.

ReferenceWoodford, M. (2003) ‘Optimal Monetary Policy Inertia’, Review of

Economic Studies, 70, 861–886.

Jahyun Koo is a researcher at the Korean Central Bank. He recentlyobtained his PhD at the University of Lancaster.

Ivan Paya is Professor of Economics at the University of Lancaster(i.paya@lancaster.ac.uk).

David Peel is Professor of Economics at the University of Lancaster(d.peel@lancaster.ac.uk).

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