Monetary Policy in Hard Times. The Political Permissibility Space of Central Banks’ Reaction Function

This paper investigates the renewed policy quandaries that central banks have faced since the start of the crisis by mapping the unconventional positions they took in the monetary policy space from 2008 till 2015. Based on the findings of an automated text analysis of the speeches of four monetary policy setting committees, the paper then investigates the factors that explain central banks’ position-taking in comparative perspective and over time. Specifically, it asks why monetary authorities in the United States, the United Kingdom, Japan and the European Union handled the trade-offs between the risks of unconventional monetary policy differently. Existing literature on central banks’ behavior explain cross-country variation in monetary policy in terms of different institutional arrangements or underlying economic variables that trigger central banks’ reaction function. Although both the institutionalist and the rationalist explanations offer important insights on central banks’ behavior, they share a common flaw: they have little to say about the mechanisms that shape central banks’ preferences over time. In order to fill in this gap, the paper draws attention to the political factors that shape central banks’ permissibility space – that is, the factors that allow the central bank to mitigate the political risks of unconventional monetary policy by providing central banks with either a shield or a justification for its unconventional stance. These factors are national traditions of policy-making, internal decision-making systems and regulatory capacity.