Central bankers draw on their experiences

It won’t surprise anyone when I say that central bankers, just like the rest of us, rely to some extent on their lifetime experiences when they do their job. The difference between central bankers and us mere mortals, however, is that their job is to set interest rates for the rest of us. So, if their experiences are skewed in some ways, that may have material consequences for the whole economy.

There are many studies that show that people instinctively adjust their expectations of future inflation and GDP growth based on their lifetime experiences. If you grow up in a time of high inflation, you are more likely to be concerned about inflation for the rest of your life, even decades after inflation has been tamed. Similarly, if your experience of economic growth is one of strong growth, you tend to be less concerned about becoming unemployed or fear recessions less than someone whose experience is one of generally lower economic growth.

Carlos Madeira from the BIS tested whether central bankers have different inflation forecasts and advocate for tighter monetary policy if they have a lifetime of higher inflation experiences. And indeed, central bankers who have experienced higher inflation during their lifetime give more hawkish speeches, forecast higher inflation than peers with lower inflation experience and vote for higher interest rates.

This tendency is particularly pronounced in emerging markets and inflation-targeting economies. A one percentage point increase in lifetime experience of inflation leads to central bankers in emerging markets voting for 0.3% higher policy rates. In inflation-targeting economies, it leads to 0.2% higher policy rates, while in advanced countries, the influence of individual experience is generally more contained at 0.06%.

Impact of 1ppt higher inflation experience on policy rates

Madeira tries to identify why personal inflation experience influences policy rates less in advanced economies and finds that, in general, it is a broader range of experiences of these central bankers, including PhDs from US and UK universities and international professional careers before they become policy makers. He hypothesises that it is this broader range of experiences and possibly a training that emphasises quantitative models that leads to less reliance on personal experiences. In other words, central bankers in advanced economies are more technocratic than in emerging markets, and that leads to policy rates that are set somewhat ‘more objectively’.