Wednesday, November 17, 2010

On making good decisions..Norway Bank

Norway Central Bank Deputy Governor Jan F. Qvigstad gives a superb speech on the "On making good decisions". The speech revolves around how central banks make decisions and what makes a decision good or bad .
It cover the following areas:
  • Independence provides a sound framework for interest rate decision
Most countries have now delegated the task of ensuring price stability to the central bank. The government has set an inflation target for monetary policy and delegated the operational conduct of monetary policy to Central Bank
The Norwegian economist Finn Kydland received the Nobel Prize for economics in 2004 for having shown that on the whole, monetary policy decisions are better if policymakers delegate interest rate setting to an independent central bank under a clear mandate
  • We make decisions under uncertainty
Independence alone does not guarantee good decisions. Even if an independent central bank is better positioned to avoid having short-term expediency and changing preferences dictate interest rate policy, its decisions must be made under considerable uncertainty.
“Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape”....Alan Greenspan
  • Groups often make better decisions than individuals
Contestants on the television game show Who Wants to Be a Millionaire? have various so-called “lifelines”, including telephoning a smart friend or asking the studio audience for help. It has transpired that the studio audience is the contestants’ absolute best bet. The majority of the studio audience votes for the correct answer nine out of ten times, beating out smart friends, who provide the correct answer only 65 per cent of the time
  • But groups are no guarantee for good decisions
The deliberative process does not necessarily lead to a better decision. When the group members share the same world view and thinking, groupthink can lead the members astray. There is typically little dissent in discussions where participants think alike. The group can therefore be convinced that their common standpoint must be right.
  • How do we arrive at a decision?
There two approaches: premise-based or conclusion-based. The two approaches may have different outcomes. Many will favour the premise-based approach because it gives weight to the underlying basis for the decisions we make.
  • Was the decision good?
The objective of monetary policy is a natural place to begin our assessment. Have we or have we not achieved price stability? Even if we make our best efforts, there is no guarantee that we will succeed in reaching this objective. The key policy rate is not the only factor affecting the economy and that can disturb the outcome.

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