RUHR. European Monetary Policy and the ECB Rotation Model ECONOMIC PAPERS. Voting Power of the Core versus the Periphery #175

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1 RUHR ECONOMIC PAPERS Ansgar Belke Barbara von Schnurben European Monetary Polcy and the ECB Rotaton Model Votng Power of the Core versus the Perphery #175

2 Imprnt Ruhr Economc Papers Publshed by Ruhr-Unverstät Bochum (RUB), Department of Economcs Unverstätsstr. 150, Bochum, Germany Technsche Unverstät Dortmund, Department of Economc and Socal Scences Vogelpothsweg 87, Dortmund, Germany Unverstät Dusburg-Essen, Department of Economcs Unverstätsstr. 12, Essen, Germany Rhensch-Westfälsches Insttut für Wrtschaftsforschung (RWI) Hohenzollernstr. 1-3, Essen, Germany Edtors Prof. Dr. Thomas K. Bauer RUB, Department of Economcs, Emprcal Economcs Phone: +49 (0) 234/ , e-mal: Prof. Dr. Wolfgang Lennger Technsche Unverstät Dortmund, Department of Economc and Socal Scences Economcs Mcroeconomcs Phone: +49 (0) 231/ , emal: Prof. Dr. Volker Clausen Unversty of Dusburg-Essen, Department of Economcs Internatonal Economcs Phone: +49 (0) 201/ , e-mal: Prof. Dr. Chrstoph M. Schmdt RWI, Phone: +49 (0) 201/ , e-mal: Edtoral Off ce Joachm Schmdt RWI, Phone: +49 (0) 201/ , e-mal: Ruhr Economc Papers #175 Responsble Edtor: Volker Clausen All rghts reserved. Bochum, Dortmund, Dusburg, Essen, Germany, 2010 ISSN (onlne) ISBN The workng papers publshed n the Seres consttute work n progress crculated to stmulate dscusson and crtcal comments. Vews expressed represent exclusvely the authors own opnons and do not necessarly reflect those of the edtors.

3 Ruhr Economc Papers #175 Ansgar Belke and Barbara von Schnurben European Monetary Polcy and the ECB Rotaton Model Votng Power of the Core versus the Perphery

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5 Ansgar Belke and Barbara von Schnurben 1 European Monetary Polcy and the ECB Rotaton Model Votng Power of the Core versus the Perphery Abstract We analyze the ECB Governng Councl s votng procedures. The lterature has by now dscussed numerous aspects of the rotaton model but does not account for many nsttutonal aspects of the votng procedure of the GC. Usng the randomzaton scheme based on the multlnear extenson (MLE) of games, we try to close three of these gaps. Frst, we ntegrate specfc preferences of natonal central bank presdents,.e. ther desred nterest rates. Second, we address the agenda-settng power of the ECB presdent. Thrd, we do not smulate an average of the decsons but look at every relevant pont n tme separately. JEL Classfcaton: D72, D78, E58 Keywords: Euro area; European Central Bank; monetary polcy; rotaton; votng rghts March Ansgar Belke, Unversty of Dusburg-Essen and IZA Bonn; Barbara von Schnurben, Unversty of Dusburg-Essen. We thank Francesco Passarell and Jason Barr for provdng us wth the algorthm to deal wth the multlnear extenson of games, Agnès Benassy-Quéré for makng her calculatons of Natonal Central Bank Governors desred nterest rates avalable to us. All correspondence to Ansgar Belke, Unversty of Dusburg-Essen, Campus Essen, Department of Economcs, Essen, Germany, e-mal: ansgar.belke@un-due.de.

6 -4-1. Introducton In the ECB Governng Councl (GC), the monetary polcy decson body of the ECB, each of the currently 22 (6 members of the Executve Board and 16 Presdents of the Central Banks of the euro area) members s treated equally n votng stuatons accordng to the one memberone vote rule. Although the decsons are supposed to be made followng a smple majorty rule, untl today they are sad to be taken unanmously (Servas, 2006). But the growng heterogenety of an ever enlargng euro area could well put an end to ths tradton. The perspectve of a euro area enlargement to the current border of the EU countres and of the GC to 33 members has enforced the necessty of a reform of ts votng modaltes, amng to enable the GC to decde tmely and effcently about ECB s monetary polcy. The European Councl of 21 March 2003 has modfed the relevant Artcle 10.2 of the statutes of the Eurosystem n favour of an ECB s reform proposal, the so-called rotaton model. Accordng to these changes (and later decsons), the rotaton of votng rghts n the CG model wll set n wth euro area enlargement to 19 members. Then, the number of votes allotted to natonal representatves wll be reduced to 15, whle leavng 6 votes to the Executve Board. Any assessment of the rotaton model comes along wth the queston whether t ensures that the ECB s man decson body can act effcently and n the nterest of the whole currency area. It has frequently been clamed that the exchange of opnons among 21 members mght already be too tme-consumng for a monetary polcy decson body that meets twce a month, especally f all 33 members are allowed to be present and to speak n the meetngs (Belke, 2003; Gros, 2003). However, ths caveat shall not be central n ths study. The second queston concernng the effectveness of GC s monetary polcy relates to a fear of renatonalsaton of ECB s monetary polcy due to the heterogenety of ts growng number of members. The latter queston s frequently lnked to the assessment of the role of the Executve Board (EB) n a reformed GC. Its members are elected as European experts on the European but not on the natonal level. Whle there s some theoretcal evdence for a natonal bas n the votng behavour of the Natonal Central Bank (NCB) governors, 1 the members of EB are frequently supposed to take a purely European perspectve. 2 Nevertheless, some studes support the vew that the charges for the rotaton model are to the account of the Executve Board (Wdgrén, 2008; Fahrholz/ Mohl, 2006), whereas other studes dentfy a 1 For nstance, Meade/ Sheets (2005) show that there exsts some regonal bas n the votng pattern of the members of the Federal Open Market Commttee. 2 See, for nstance, Belke/ Styczynska (2006) and Bénassy-Quéré/ Turksch (2009).

7 -5- strengthenng of ts role (Belke/ Styczynska, 2006; Bénassy-Quéré/ Turksch, 2009; Kosor et al., 2008). In the present study, we re-examne ths queston n the context of a power ndex analyss. We construct a model whch s novel n several aspects. Frst, we are able to consder the detals on the precse form of the rotaton publshed only recently (ECB, 2009). Thanks to them, we avod the average vew taken n several game theoretcal studes and report power ndces for separate votng events. Second, we wll explctly model the preferences of all members of the GC. Fnally, we wll account for the role of the ECB presdent as the agenda-setter. In our analyss, we use the preference-based power ndex approach orgnally proposed by Passarell/ Barr (2007). In general, power ndces measure the potental nfluence of a player on the outcome of a game or, expressed dfferently, the probablty that a player determnes ts outcome. Ths s usually formalsed by the expected margnal contrbuton of the player to a random coalton of players establshed before hs arrval. Whle symmetrc values lke the Shapley-Shubk ndex only account for the number of players n the random coaltons, quas-values lke the preference-based ndex by Passarell/ Barr (2007) accommodate alternatve randomzaton schemes. Based on the multlnear extenson of games (Owen, 1977), Passarell/ Barr (2007) develop a power measure based on two assumptons: (1) the dstance between a player s poltcal poston and the dscussed ssue determnes hs probablty of votng yes ; (2) the swngng votes of players n votes about hghly lkely ssues are weghted hgher n the power ndex than those n less lkely ssues. The resultng value enables the consderaton of the players and an agenda-setter s preferences. Wth ths approach we further pursut and even extend the way taken n Belke/ Styczynska (2006) and analyse the GC s votng as a cooperatve game. We feel legtmzed to argue that ths vew dsplays the characterstcs of the votng stuaton n ths monetary commttee n an approprate way, whch accounts for both the collegal character as well as some degree of partsan behavour. By the collegal character, we mean the clam that NCB governors take part n GC meetngs as equal experts who do not focus on the natonal but on the European perspectve. Ths pont of vew s always emphaszed by the offcal statements by ECB offcals but s also reflected n the tradton of nformal meetngs (on the eve of every GC meetng), as well as n the one member-one vote prncple (whch s stll n force today and wll reman so untl the accesson of the 19 th euro area member). At the same tme, most studes consder a regonal bas n the governors votng behavour as a not too

8 -6- unrealstc scenaro (Bndsel 2001; Henemann/ Hüfner 2004; Fahrholz/ Mohl 2008; Ullrch 2004; Schulze 2005; Bénassy-Quéré 2009). Startng from a study by Meade/ Sheets (2005), some other studes also consder a regonal bas n the votng behavour of the EB s members (Ullrch 2004; Kosor et al. 2008). Because of the contradctons between the ECB s wordng and the results of the studes, a cooperatve modellng of the votng game whch explctly accounts for ndvdual preferences s hghly ndcatve and should come to nterestng results. As far as the preferences of natonal central bank presdents (NBPs) are concerned, we have decded to go beyond many studes and to consder a broader measure of macroeconomc dvergence than merely regardng nflaton preferences of the member states. Ths s made possble by the approach of Bénassy-Quéré/ Turksch (2009). The authors smulate desred nterest rates of NBPs by the Taylor rule and, thus, enable us to take dfferent country-specfc preferences for nflaton nto account. Ths method can be seen as a good approxmaton of future preferences of NBPs, and represents the future macroeconomc developments better than past nflaton rates. In the approach of Bénassy-Quéré/ Turksch (2009), the medan voter concept s used to smulate the decson makng. One of the results s an outstandng nfluence of the Executve Board. The authors observe that the EB always takes a medan poston n the poltcal space. Ths pattern ncreases ts measured nfluence as compared to the nfluence measured by classcal power ndces. In our analyss, we fully account for the poston of all actors n the poltcal space. We are also able to consder a further mportant characterstc of the EB,.e. ts agenda-settng power. It wll be shown that the advantageous poston of the EB on the polcy space together wth ts agenda-settng power results n an outstandng poston of the EB n the GC n terms of power ndces. The remander of the paper proceeds as follows. In secton 2, we revew the relevant lterature. In Secton 3, the new ECB rotaton model s descrbed n detal. In secton 4, the theoretcal model and the setup of our calculatons are presented. We come up wth our emprcal results n Secton 5. Secton 6 fnally concludes. 2. Revew of the relevant lterature Decson makng n monetary polcy commttees s subject of a fast growng branch of lterature. There exst approaches that develop optmal desgns from a theoretcal pont of vew as well as assessments of exstng decson rules. The optmal desgn of a monetary polcy commttee ncludes a defnton of the optmal sze, composton and votng rule

9 -7- (Gerlng et al. 2003). As t s out of queston by now that the rotaton model wll not be modfed, and our analyss concentrates on an assessment of ths rule, we wll focus on the studes that also analyse the rotaton model wth the power ndex concept. Untl today, there exst only a few studes that analyse the power allocaton n the ECB GC (e.g. Belke/ Styczynska, 2004 and 2006; Fahrholz/ Mohl, 2006 and Ullrch, 2004, Kosor et al., 2008). Whle Belke/ Styczynska (2004 and 2006) and Fahrholz/ Mohl (2004, 2006 and 2008) pursut dfferent ways of analyss, Ullrch s (2004) research s based upon the method presented n the frstly noted publcaton. There, an nter-temporal approach has been chosen n order to vsualse the effect of the planned reform of the ECB GC, wthout any knowledge of the precse rotaton modaltes, whch have been announced n December One of the mportant assumptons there s that NBPs form coaltons that are persstent over tme. These coaltons are not necessarly dentcal wth the groups that defne the votng frequences. The ntutve dea s that NBP tend to agree upon a votng n whch the nterest of each coalton member s represented even though only some hold the votng rght n a precse moment of tme. Then, relatve votng frequences can be nterpreted as votng weghts n an ntertemporal game. 4 As a consequence the resultng power ndces are not values of players n an exact moment of tme, but average values over tme. 5 Ths aspect of the study has been frequently crtcsed (e.g. Bénassy-Quéré/ Turksch, 2009; Kosor et al., 2008) because the average consderaton always leads to a loss of nformaton. We wll fully account for ths crtque n ths study and only analyse sngle ponts of tme and base our conclusons on a comparson of sngle votng stuatons rather than on averagng. Ullrch (2004) also chooses the nter-temporal vew n her votng power analyss. Usng ths method, she analyses the dscrepancy between the poltcal weght of NBPs and the economc weght of ther countres of orgn. In contrast to these two analyses, Fahrholz/ Mohl (2004, 2006 and 2008) choose other possbltes to apply the power ndex concept to 3 ECB (2009). 4 We do not follow Fahrholz/ Mohl (2006 and 2008) n ther negatve assessment of the nter-temporal approach. They construct an example whch s supposed to demonstrate the dsutlty of, for nstance, the approach taken by Belke/ Styczynska (2006). For ths purpose, they nclude a player n the game who has some mnor votng power (he can be pvotal n few coaltons) but s a dummy as far as the frequency of votng s concerned. Unfortunately, ths example has a major drawback. Every player that s pvotal n at least one permutaton needs to take part n the votng game, and consequently has a strctly postve votng frequency. In ths case, the addton of such a player would lead to a shft n the relatve votng weghts of all other players already by defnton of these weghts and hence result n a re-apportonment of power ndces. If, on the contrary, a player was a dummy n terms of frequency votng, he would never take part n the game and could never exert pvotal nfluence on a coalton. Consequently, Fahrholz/ Mohl s conclusons are nternally nconsstent. 5 Ths holds because of the addtvty property of the Shapley-Shubk ndex.

10 -8- the rotaton model. In ther frst attempt to calculate the power ndces n the GC under rotaton, they model each group of players as a coalton (Fahrholz/ Mohl 2004) 6. Ths assumpton unfortunately nether accounts for the nfluence of a sngle player nor for the typcal characterstcs of rotaton where tme s one of the relevant varables. Behnd ths modellng, the strong assumpton of every group actng lke a coalton s hdden, whch can be doubted especally n the most heterogeneous group two. In a further attempt to assess the rotaton model (Fahrholz/ Mohl 2006 und 2008) the authors construct a game n whch every NBP has one vote whle the EB s consdered as one player wth 6 votes. They compute socalled prelmnary Banzhaf ndces for ths game and weght the result wth the absolute votng frequences. Already from ths descrpton, t can be followed that ths approach does not account for the characterstcs of the rotaton ether. Ths votng game whch forms the bass of further calculatons wll never take place as such. Consequently, the votng dynamcs captured by the Banzhaf ndces are msleadng as they nether represent a concrete allocaton of votng power nor the average over several meetngs lke n the approach of Belke/ Styczynska (2006). A recent study n ths feld has also been publshed by the Polsh Natonal Bank (Kosor, et al. 2008). The authors come to the result that the rotaton model strengthens the power of the EB, but that ths gan n power s lower f preferences of the members of the GC are taken nto account. Ths study s smlar to the present approach n two mportant aspects: frst, lke Kosor et al. (2008), we also consder sngle votng stuatons as bass for the analyss; second, both studes consder the preferences of the members of the GC. Nevertheless, both aspects are treated n a dfferent way. Whle Kosor et al. (2008) report an average power ndex for a large number of meetngs, we wll consder the power dstrbuton for several sngle ponts of tme. Furthermore, the authors use the nformaton of nterest rate preferences n order to defne pre-coaltons n the GC and calculate the Shapley-Shubkndex for a commttee wth several pre-coaltons and sngle players. Whereas n our approach the preferences of the players determne the probabltes for coalton formng. Any coalton s defned to be ex ante mpossble, strange coaltons only have a very low probablty. Ths may represent the votng stuatons of the GC n a way that s closer to realty, especally f we consder future developments. Further, Kosor et al. (2008) could not have consdered the rotaton detals that have been publshed n 2009 (ECB, 2009) and make wrong assumpton about them. 6 They take an approach smlar to Haubrch/ Humpage (2001).

11 -9- We concede that the nter-temporal vew chosen n Belke/ Styczynska (2006) despte the nterestng results only represents a smplfed vew on the rotaton model. We already agreed that some expanson of ths approach s needed n order to analyse the rotaton model as closely as possble. The dscusson of the relevant lterature has further shown that there s stll scope and need for further research n ths area. In ths paper, we wll account for three mportant aspects and present a novel and realstc model of the votng n the ECB s central decson body. Frst, we wll account for the preferences of NBPs. We wll consder dfferent desred rates of the NBP n dependence of ther home economes. Second, we wll account for the agenda-settng power. And fnally, we wll take nto account the tme axs and calculate the ndces for votng stuatons that wll actually take place. 3. The rotaton model The organsaton of decson makng n the ECB s of great mportance for ts ablty to acheve ts most mportant goal: prce stablty. The number of members of monetary decson makng bodes has to be balanced between the need of effcent and effectve decson makng and an adequate representaton of regons. The frst requrement s better fulflled by a smaller, the second by a larger commttee, especally n the case of the ECB. Successful central banks such as the US Fed and the Bundesbank have frequently decded to have smaller decson makng bodes at the cost of a full representaton of the regons; but not so the ECB, where once the rotaton model comes nto force, 15 regonal representatves and 6 members of the EB have a rght to vote, whle all (up to 27) NCBs attend the meetngs. We summarse some further characterstcs of the rotaton model below. o The reducton of votng rghts from one member-one vote to the rotaton model s carred out by means of an ndcator of economc mportance. 7 After rankng the countres accordng to ths ndcator, ther representatves are assgned to one of three groups. 8 The votng rghts rotate among the members of each group, whle the votng frequences are hghest for the members of group 1 and lowest for the members of group 3. 7 Ths ndcator conssts of a fve-sxth share of euro GDP at market prces and a one-sxth share n the aggregated balance sheet of the euro area monetary fnancal nsttutons (MFIs). 8 There s a transton phase n whch only 2 groups are formed, as long as the euro area conssts of 19 to 21 members.

12 -10- o In a euro area of 27 the ECB s Governng Councl would consst of 27 NCB governors and sx drectors. Accordng to the ECB s rotaton model, votng rghts would n the end be dvded as follows (see Table 2): o The sx drectors would possess a permanent rght to vote. o The fve bggest countres (Germany, France, Italy, the UK and Span) would represent the frst group and be allocated a total of four votes,.e. the respectve natonal central bank governors would have to suspend ther votng rght n one-ffth of the meetngs. o A total of 8 votes would be assgned to the NCB governors of 14 mddle-szed member countres. Thus, the partcpants of ths group would be enttled to vote n only 57% of all decsons. o The remanng 8 NCB governors would only be allocated 3 rghts to vote, whch mples that they would be suspended from 62.5% of the votng dates. o Irrespectve of ther specfc votng rghts, all NCB governors would be able to partcpate n the dscussons on the monetary polcy of the ECB Governng Councl. It s mportant to ncorporate some further detals of the rotaton model that have been publshed only recently by the ECB (ECB, 2009) n any game-theoretc analyss of ECB votng behavour. Accordng to these newly avalable detals, rotaton (.e. a change n the allocaton of votng rghts) wll take place monthly. In contrast to earler speculatons n the lterature (e.g. Kosor et al., 2008), not every NCB governor who was suspended from votng n the prevous perod wll regan hs votng rght n the followng month. The number of the so-called rotatng NCBs wll be determned by the dfference between the number of natonal representatves n the GC and the number of votes allocated to each group mnus two, takng the absolute value n case of a negatve number. The ECB clams that ths mode of rotaton guarantees the hghest level of stablty n the composton of the GC combned wth only short perods of absence. Ths statement s somehow supported by Tables 1 and 2 n whch two examples of the rotaton mode for 6 months are presented. Vsbly, the changes n the composton of the commttee are relatvely gentle. The startng pont of the rotaton wll be a random pont n an alphabetcally ordered 9 lst of the euro area members. We wll consder 9 The lstng of the countres follows the standard of the EU, where countres are lsted alphabetcally accordng to ther names usng the Latn alphabet, see e.g. Table 4.

13 -11- exactly the scenaros n Table 1 and 2 (22 versus 27 euro area members) n our calculatons of the preference-based power measure n secton 5 and take one possble startng pont and succeedng 6 months nto account. The observed stablty,.e. the absence of strong month-tomonth shfts, as shown later does hold for the allocaton of votng power wthn certan lmts. Table 1 - Rotaton of votng rghts (6 months, 22 euro area members) 22 number of players votes members wthout votng rght rotatng player group t1 t2 t3 T4 t5 T6 Exerted votng rghts n 6months a a a a a group b b b b b b b b b b b group c c c c c c sum: Source: Own calculatons, based on ECB (2009). Note that Tables 1 and 2 reveal one further mportant characterstc of the rotaton model: even f t allocates votng rghts equally between the members of each group on average, ths s not the case at sngle perods n tme. The exerted frequency of votng after 6

14 -12- months can vary for the members of group 2 between 3 and 6 tmes, ex post. In other scenaros and tme perspectves ths nterval mght even be hgher. Another example could be a snapshot after 12 months. Wth 24 NBPs, each member of the second group would have voted 8 tmes, a member of the frst group between 9 and 10 tmes. In ths case, the frequency of votes ex post also vares substantally for the members of the thrd group. In ths tme perod, members of ths group would vote between 4 and 6 tmes. The ex post nequalty resultng from these ntervals s even hgher n the case of 21 NBPs n the GC where the members of the frst group have exerted ther votng rghts 9-10 tmes, whle a NBP contaned n the second group has voted between 6 and 10 tmes after one year. Table 2 - Rotaton of votng rghts (6 months, 27 euro area members) 27 number of players votes members wthout votng rght rotatng player Exerted votng rghts n 6months t1 t2 t3 t4 T5 t6 group a a a a a group b b b b b b b b b b b b b b group c c c c c c c c sum: Source: Own calculatons, based on ECB (2009).

15 -13- Obvously, the date of enlargement of the Governng Councl wll never be defned by questons of a just enttlement wth votng rghts but by the moment of accesson of a country to the euro area whch s determned by the Maastrcht crtera. Ths s why the transformaton from one rotaton schedule to a new one wll occur only by chance specfcally n a moment where the NBPs of a group have exerted ther votes equally frequently. Moreover, there exsts nearly no possblty of ths occurrng for all concerned groups at the same tme, 10 whereas the dfferences resultng n a randomly chosen pont of tme mght even be large. Ths knd of unequal treatment of members of one group has been consdered by the ECB only n so far as t consders the case that a NCB has to sustan ts vote always n the same perods of the year. Then, dscretonary changes n the composton of the GC can be decded upon. 11 We take nto account ths new pece of nformaton about the rotaton procedure and explctly consder the preferences of NCB governors n our model. Ths enables us to assess whch consequences on the allocaton of power result from the ntroducton of the rotaton model. In the followng, we ntroduce the preference-based power measure (Passarell/ Barr, 2007) whch we wll use later on n our analyss. 4. The theoretcal model 4.1. The preference-based power measure of Passarell/ Barr (2007) Classcal power ndces focus on effects of formal rules on the ndvdual power of sngle players. Hereby, they abstract from possble preferences players could have n coaltons buldng and only consder nformaton about votng rules and weghts. These ndces are useful f preferences are unknown or varable, or f a study concentrates on the effects of the formal votng rules. However, f nformaton about preferences of the players s avalable, t can be used to generate a more detaled vew of the votng body. Passarell/ Barr (2007) consder a votng body whose members have preferences that can be mapped on a polcy space and where the set of voted ssues s random. They construct a power measure based on a randomzaton scheme wth the followng appealng characterstcs. Frst, the dstance between the deal pont of a player and the voted ssue determnes the probablty of ths player to vote yes to the concernng ssue. The larger ths dstance, the lower ths 10 The perod of tme after whch each NBP n GC has exerted hs votng rght exactly as often as each NBP n hs group s lower than the product of the equalsaton frequences only n cases where one frequency s an exact multple at least one other, lke n the case of 20 NBPs. 11 Artcle 1.1 of the mplementng decson runs as follows: The Governng Councl may decde to change the order of rotaton for the second and thrd groups to avod the stuaton that certan governors are always wthout a votng rght at the same perods of the year.

16 -14- probablty wll be. Second, beng pvotal n a hghly lkely votng amplfes a player s power measure to a larger extent than beng pvotal n a less lkely votng. An agenda-setter can be modelled by a dstorton of the dstrbuton of the voted. Ths preference-based power measure s applcable to the GC because the preferences of ts members can be mapped on a polcy space. It enables us to consder the preferences of the GC members and to ntroduce the ECB s Presdent as agenda-setter. 12 In the followng, we consder a weghted majorty game wth the player set N N={1,2,,n}. S s called a coalton f S N. The characterstc functon v ( 2 R ) assgns 1 to a wnnng coalton (v(s)=1) and 0 to a losng coalton (v(s)=0). A coalton s a wnnng one f ts members dspose of the requred majorty of votes m: beng the votng weght of player. S w m, wth w The multlnear extenson of games presented by Owen (1972) makes t possble to ntroduce randomzaton n the coalton formaton. Then, a player s not necessarly ether member or outsder of a coalton S, but jons ths coalton wth a certan probablty. Consder as an example a 3-players game and the coalton S={1,2}. A coalton can be wrtten as a vector wth x =1(0) f s a member of the coalton (s not a member of the coalton). In our example, we wrte for S=(1,1,0). If 0 x 1, then x can be nterpreted as the probablty that player partcpates n coalton S ( ). The probablty for coalton S to occur s then gven by: P S) = x ( 1 x ) (. S S The multlnear extenson (MLE) of a game v (Owen, 1972) enters the followng expresson: f ( x 1,..., xn ) = x (1 x ) v( S), S N S S whch represents the expected value of the game n ths settng. 12 Ths s also possble wth the Owen-Shapley method (Owen and Shapley, 1989). The Passarell/ Barr method has the advantage that, contrary to the Owen-Shapley method, the probablty of zero s not assgned to any coalton a pror. Rather, very unlkely coaltons are assgned a very low probablty (Passarell/ Barr, 2007, p. 43). Further contrbutons to the lterature of preference-based power measures can be found n Napel/ Wdgrén (2004 and 2005).

17 -15- The expected margnal contrbuton by player s gven by the partal dervatve of the MLE functon wth respect to x and can be nterpreted as a power measure n smple games (Owen, 1972): x j ( x )[ v( S {} ) v( S) ] f ( x,..., x ) = 1. n S N j S S j S j Let us now consder some addtonal assumptons wthn the Passarell/ Barr (2007) model framework. Let poltcal ssue. ( ) θ m Θ R be a poltcal m-dmensonal space, and θ Θ a random p s the densty functon of θ, wth ( ) Coaltons are formed at random. ( θ ) n the coalton S( θ ) N Θ p θ dθ = 1. q descrbes the probablty that wll partcpate. Ths functon s sngle-peaked n P and P descrbes the deal pont of player. Player jons S( P ) wth the probablty 1 ( q ( P ) = 1). In the settng of votng games the probablty ( θ ) q can also be nterpreted as the lkelhood that player votes yes to ssue θ. If hs deal pont s dscussed, player always votes yes. The preference-based power measure ψ (Passarell/ Barr 2007) of player s defned as the expected value of f gven the above randomzaton structure: ψ ( θ ) p( θ ) = f dθ. Θ ψ φ = n. j= 1 We wll consder the normalzed verson of ths measure: ψ j The preference-based power measure has orgnally been appled by Passarell/ Barr (2009) to analyse the dstrbuton of votng power wthn the European Commsson, where the respectve emprcal realsaton of an ndcator of eurosceptsm (Eurobarometer) s nterpreted as the Commsson members preferences. Analogously, we nterpret the countryspecfc emprcal realsatons of an ndcator of the future economc development (here: the

18 -16- nflaton rate) as preferences of the members of the euro area. 13 Such an ndcator has been developed by Bénassy-Quéré/ Turksch (2009). In ther case, the latter represents an estmaton of nterest rate preferences of the euro area member states. We wll descrbe t brefly n the followng Preference-based power measure for the GC Interest rate preferences The am of the approach taken by Bénassy-Quéré/ Turksch (2009) s to study the coreperphery balance of nterest rate preferences wthn the GC. The authors apply the medan voter concept to the GC by explctly modellng the nterest rates preferences of ts members. The latter are calculated for the GC members referrng to smple Taylor rules and based on a convergence assumpton relyng on a specfc set of assumptons (among others, lnear convergence of prce levels wthn 30 years) concernng the convergence of the economes towards the euro-12 aggregate. 14 It s well over a decade snce John B. Taylor set out what has become part of the current orthodoxy of monetary economcs by now. In hs semnal paper, John B. Taylor (1993) shows that the monetary polcy decsons of central banks can be descrbed reasonably well by a smple reacton equaton. The latter s usually modelled as a functon of, among others, nflaton and the output gap. Despte ts smplcty, the Taylor reacton functon has been shown to have a hgh degree of relance n explanng monetary polcy. 15 Bénassy-Quéré/ Turksch (2009) start wth four versons of the Taylor rule. We have fnally have decded to strctly follow Bénassy-Quéré/ Turksch (2009) and to omt those consderng shocks n the output gap, because t s rather arbtrary to calbrate future shocks and the estmaton of the output gaps heavly reles on varance-covarance matrces of the past. The latter mght prove crtcal especally f one takes nto account that even the euro-22 scenaro (not to menton the euro-27 scenaro) wll become realty rather far away n the future. 16 Hence, we ether stck to the truncated verson of the Taylor rule or assume that nflaton 13 Remember that Bénassy-Quéré/ Turksch (2009) derve some estmates of the future nflaton rate and, thus, also the future preferred Taylor nterest rate. We follow ther approach because the scenaros of 22 and 27 members of the euro area whch we focus on are also located n the future. In order to analyze these scenaros, we have to consder an ndcator for future monetary polcy preferences. 14 Ths aggregate refers to the area of the EU between 2000 and Ths has been shown, for nstance, for the countres of the EMU n by Gerlach/ Schnabel (2000). 16 Techncally, t s also possble to apply the other versons as well. Our results do not change dramatcally n ths case and are avalable on request.

19 -17- targets equal the actual country-specfc nflaton rates. We feel legtmzed to proceed lke that wth an eye on the lmts n forecastng busness cycle convergence and the fact that the remanng two scenaros map the nterest rate preferences n a suffcently accurate fashon for our purposes. 17 The frst scenaro s the truncated verson of the Taylor rule n whch no output gap s consdered and a ~ π = 2 % nflaton target s assumed. Consequently, the short-term nomnal k nterest rate of country k s derved from ts neutral nterest rate r k, ts nflaton rate π k and ts target nflaton rate k r k k ~ π k : ( π π ) = + π ~. (truncated Taylor rule) k k In the second scenaro, calculated as a robustness check, we assume country-specfc nflaton targets. Here the nflaton targets equal the actual nflaton rates. In ths case, the Taylor rule bols down to the Fsher equaton: = + π. k r k k (Fsher rule) The preferred nterest rates apply to the future performance of the economes of the euro area. Bénassy-Quéré/ Turksch (2009) choose to forecast the nflaton rate based on the assumpton of a lnear convergence of the prce levels to the euro-12 aggregate n 2007 wthn 30 years. 18 Assumng lnear convergence allows dsregardng the exact moment of enlargement and s also of specal nterest for our approach. The neutral levels of real nterest rates are set equal to the long-run real GDP growth. 19 The preferred nterest rates are reported together wth the results n secton 5, for nstance, n Table 4. There, t can be observed that countres n group 3 are relatvely hawksh as compared to the Board or the members of group one, whle group 2 unsurprsngly turns out to be the most heterogeneous as t concerns the preferred nterest rates. 20 Ths s due to the central nfluence of nflaton n the Taylor-rule Nevertheless, we have recalculated our man results usng the nterest rate preferences calculated by Bénassy- Quéré/ Turksch (2009) for the scenaros of postve and negatve output shocks. These results are n lne wth those presented later n ths paper and are avalable from the authors upon request. 18 The euro-12 aggregate relates to the euro area permeter from 2000 to For further detals on the calculatons and data sources, see Bénassy-Quéré/ Turksch (2009, pp ). 20 Ths observaton s equally vald f the output gap s consdered (postve/ negatve shocks). The remanng varatons between the preferred nterest rates due to dfferent calculatons have only a mnor nfluence on our calculatons, because we are nterested n the balance between the European and the natonalstc vew n the GC and the poston of the European vew s very stable over all possble calculatons. 21 Smlar results concernng preferred nterest rates are presented n Berger/ de Haan (2003).

20 -18- Bénassy-Quéré/ Turksch (2009) use ther results to smulate the GC s decson by means of the medan voter approach. Hereby, they assume the NCB governors to vote as natonalst representatves of ther home countres ( home bas ) and the EB as a representatve of the euro vew. Nevertheless, the authors do not queston the applcablty of ths assumpton, but clam to desgn a worst case scenaro whch reveals the ablty of the rotaton model to cope wth natonalstc preferences. We strctly follow ths approach n our study. As wll be shown n the followng chapter, we also consder scenaros n whch the EB s not homogeneous but consstng of natonal representatves. As we focus on the balance of power between the natonal and euro-wde preferences, we always model at least one representatve of each vew. Euro area enlargement - consdered scenaros In ths study, we focus on the scenaro of euro area enlargement up to 22 members. As opposed to a scenaro of 27 members, the opt-out countres (Unted Kngdom, Sweden, Denmark) as well as Romana and Bulgara 22 are not consdered here as members of the euro area. Ths s just to account for a realstc medum-term scenaro, gven the fact that all enlargement scenaros have become very fragle due to the fnancal crss. Ths would eventually represent a bg bang scenaro, accordng to whch a great number of central and mddle European countres would access the euro area at once. The votng behavour of a GC comprsng the maxmum possble number of 27 euro area member states s calculated only n the basc scenaro - just for comparatve purposes. The pattern underlyng our scenaros s represented n Table 3. In the basc scenaro, we consder natonalstc NCBs and a homogeneous EB votng as one player wth 6 votng rghts and preferences referrng to the euro area. Ths s the most common assumpton n the lterature (Belke/ Styczynska, 2006, Bndsel, 2001, Bénassy-Quéré/ Turksch, 2009). Addtonally, we calculate scenaros n whch the EB s consdered as heterogeneous. Hence, the euro vew s represented by the presdent of the ECB whle the other members act as addtonal representatves of ther countres of orgn. Hereby, we consder three possble alternatves: the actual composton of the Board 23 and two polar compostons. In the extreme scenaros, the members of EB except the ECB Presdent come from the 5 countres wth the 22 Accordng to any serous forecast, t s not very realstc that these countres wll fulfl the Maastrcht crtera n the medum term. 23 Currently, the EB comprses members from Greece, Italy, Span, Germany and Austra.

21 -19- lowest (Netherlands, Fnland, Ireland, Austra, Germany), respectvely hghest nterest rate preferences (Hungary, Slovaka, Latva, Lthuana, Poland). We consder ths specfc array of scenaros just n order to reveal the respectve effects on the allocaton of power n the GC, even though we are aware of the fact that some of them are hardly realstc from a poltcal pont of vew. Especally the consderaton of the two polar scenaros enables us to show that the composton of the Board has a major nfluence on the allocaton of power to the commttee members n the heterogenety scenaro. Expectng that further euro area enlargement wll take place not earler than wthn the not too close future and that realty wll level out at an ntermedate scenaro, the above results mark lmts for the dstrbuton of power for less extreme compostons of the EB that can hardly be estmated today. 24 In the euro area, NCB governors are generally regarded as representatves of ther countres of orgn and thus are supposed to be guded by a natonal bas n ther votng behavour. Many studes n ths feld are based on ths assumpton (Belke/ Styczynska, 2006, Bndsel, 2001, Bénassy-Quéré/ Turksch, 2009). It refers to the classcal analyss by Meade (2003a, b, c) and by Meade/ Sheets (2002, 2005) who show that a natonal bas n the decson-makng of the GC s qute probable. As long as the NCBs are regarded as representatves of ther home countres and apponted by natonal governments, the suspcon perssts that they also act as natonal representatves, and vote n favour of ther home countres. The ntroducton of the rotaton model should even renforce ths effect. Many of the studes cted above are also based on the assumpton of a homogeneous EB. Nevertheless, others have expressed ther doubts about the correctness of ths assumpton (Varela/ Sanchez-Santos, 2003). Ths s exactly why we consder three scenaros wth a heterogeneous EB. In these cases, the ECB Presdent s consdered as the representatve of the euro vew. 25 For each scenaro, we dstngush two possble settngs: wth and wthout an agenda-setter. The agenda-setter s represented by the preferences of a homogeneous EB or of the presdent hmself f the EB s heterogeneous. In a fnal step, as a robustness check, we repeat the calculatons wth the nflaton rates based on member-specfc nflaton targets as proposed by Bénassy-Quéré/ Turksch (2009). 24 Bénassy-Quéré/ Turksch (2009) consder polar scenaros of a homogeneous GC for the calculatons of the medan nterest rates under the rotaton model. 25 We are aware of the fact that some evdence has been presented for natonalst tendences n the Presdents votng behavour (Varela/ Sanchez-Santos, 2003) even though such a scenaro would be offended by the ECB tself. Our study s partcularly nterested n the balance of power between the core and the perphery, ths s why we always ntroduce a representatve of the European perspectve.

22 -20- Table 3 Number of euro area member countres - nvestgated scenaros homogeneous EB heterogeneous EB Truncated Taylor 22 members Basc* 27 members* 22 members actual* 22 members hghest* 22 members lowest* Truncated Taylor, member specfc nflaton rates 22 members Source: Own presentaton. Setup of calculatons For a proper mplementaton of our theoretcal model we have to mpose some addtonal assumptons. The latter concern the probablty generatng functon q and the modellng of the agenda-setter and have an mpact on the results. Thus, they should be chosen carefully and taken nto account when analysng the results. In the frst case, we have decded to use the standard functon ntroduced by Passarell/ Barr (2007) but to adjust the way the desred nterest rates enter ths functon. We calbrate the nputs n order to acheve a relatvely strong dscrmnaton between the coaltons and at the same tme realstc probabltes n coalton formaton. In the resultng functons, the probablty of Germany sayng yes to the euro area s preferred nterest rate turns out to be approxmately 90% n all scenaros, whle the same probablty for Poland only amounts to around 10%. The probablty generatng functon then s: π ( P θ ) (, θ ) = 2 P e q, whle the desred nterest rates enter the functon as P = 20. The preferences of the agenda-setter are always defned as the euro area s preferred nterest rate. We assume the agenda-setter to propose only nterest rates whch le wthn a range of ± 0.5% around the agenda-setter s own preferences. Because of computatonal smplcty we have chosen the followng trangular probablty functon: ( θ ) p P = P EU EU + 100θ, 100θ, P P EU EU 0.1 θ P < θ P EU EU + 0.1

23 -21- In order to calculate the ndces, we smulate the coalton formaton for 200 values of θ. For each value of θ, each player s excluded from the player set successvely. For each player, coaltons are then formed at random, gven the probablty generatng functons q. Average margnal contrbutons are calculated for each player as the relatve frequency of ths player beng pvotal n the smulated coaltons. The former are then summed up over all values of θ. The detals can best be shown referrng to the example of a fxed θ. We do ths n the followng. One mportant step of analyss - fxng the thetas Consderng the stuaton for a fxed θ corresponds to the look at a scenaro n whch the voted ssue s known and the probablty for every coalton s, thus, determned by the functons q. Accordng to our theoretcal model presented above, the power measure of a player results as hs probablty of beng pvotal n any possble coalton. Strctly followng Passarell/ Barr (2007), we calculate ths measure by means of a Monte Carlo smulaton. For each θ, the consdered player s removed from the player set as a frst step. As a second step, then, coaltons are smulated for the remanng n-1 players, gven the probablty generatng functons q. Ths allows us to estmate the probablty of coaltons agreeng to the ssue at stake, dependent on ther sze (n terms of votes). Player s pvotal n all losng coaltons that acheve the requred majorty by hs jonng. The sum of the probabltes for player beng pvotal then gves the preference-based power measure for a gven parameter θ. - Fgures 1 and 2 about here - As an example, we consder the scenaro of 22 euro area members and a homogeneous EB. Fgures 1 and 2 dsplay the estmaton of the coalton formaton for two values of θ (1 and 2), we consder the smulaton after excluson of two members of the GC, Germany and the EB respectvely as examples. 26 If a player dsposes of 6 votes, he can be pvotal n a hgher number of coaltons than a player endowed wth one vote. 27 For θ =1 ( = 0.05), an ssue close to EB s preferences s dscussed ( = ), whle θ =2 ( = 0.1) s further away from the EB s (and also from most NBPs) preferences. Ths pattern becomes manfest EB 26 Of course, choosng Germany wth one vote and the EB wth sx votes underlnes the dfferences of the results as strong as possble n our context. 27 Remember that the parameter θ amounts to 0.05 and 0.1, respectvely, accordng to secton 4.

24 -22- n the respectve relatve frequences: for θ =1 much more players (ncludng the EB) are wllng to jon the yes -coaltons than for θ =2. After excluson of Germany, the mode of the sngle-peaked frequency dstrbuton s located at a value of 15 for θ =1 and at 4 for θ =2. Apparently, the most frequent coaltons do not nclude the EB for θ =2. Whle for θ =1 the 5 most frequent coaltons n terms of sze are composed of nearly all NBPs or the EB plus 7 to 11 NBPs. We can observe analogous dfferences for both values of θ for the coalton formaton after excluson of the EB, too. Whle the mode for θ =1 s 10, t s much lower for θ =2 (4). These dstrbutons whch result from the probablty generatng functons q determne the power measures for the consdered players Germany and EB. Germany has one vote n the GC and can only be decsve for coaltons that collect 10 votes. Ther estmated probablty amounts to for θ =1 and at for θ =2 and represents the preferencebased power measure for the gven values of θ. The nfluence of a player wth one vote s generally low n a commttee wth majorty votng and overall 22 votes, but the classcal Shapley-Shubk ndex would be lower than both preference-based measures wth Thus, the poston of Germany s more nfluental n both stuatons than n the symmetrc case. If θ =1, Germany s power ndex s hgher, whch shows that for ths ssue players agree more easly and a coalton of 10 s formed wth a hgher probablty. The EB can be decsve n a larger number of coaltons, dsposng of 6 votes ts jonng turns all losng coaltons to wnnng that dspose of 5 to 10 votes. Whle the (symmetrc) Shapley-Shubk-ndex of the EB would be 0.375, the preference-based power measure dscrmnates between the two ssues dramatcally. For θ =1, the emprcal realsaton of ths power ndex even amounts to , whereas t turns out to be very much lower for θ =2 (.e., ). Ths pattern mples that n case of the frst value coaltons n the relevant range have a hgher probablty. 5. Results The basc scenaro Table 4 summarzes our results wth respect to the preference-based power measures for the basc scenaro n whch we consder a euro area wth 22 members and a homogeneous EB. In ths case, we consder the homogeneous EB as a group of experts who consstently vote n favour of the euro area. They are represented n our game as one player endowed wth sx

25 -23- votes and the preferred nterest rate whch equals the one of the euro area. In Table 4, the preference-based power measures are reported for the scenaros wthout and wth an agendasetter. At least two observatons emerge after a frst vsual nspecton of the results. On the one hand, the power ndces of the NBPs dffer n both scenaros - wth a mnmum around 0.02 and a maxmum up to On the other hand, t s vsble that the homogeneous EB has a domnant poston n the GC. Wth an MLE ndex of around 0.6 n the scenaro wthout an agenda-setter the EB s allotted a hgher power ndex than n the symmetrc Shapley- Shubk case (0.375). Ths observaton confrms the results of Bénassy-Quéré/ Turksch (2009) who have already dscussed the EB s favourable poston on the polcy space n ths scenaro. However, especally n the scenaro n whch EB sets the agenda of the votng, t s attrbuted the bulk part of the nfluence on the votng outcome wth 95% to 96% of power. - Table 4 about here - Fgures 3 and 4 allow a closer look on the allocaton of power n the GC concernng these two observatons. In Fgure 3, the values of the preference-based power measure for all consdered ponts of tme are compared for the EB and the scenaros wth and wthout agenda-setter. In the second scenaro, we see the power of the EB stablsed on a very hgh level. In the frst scenaro, we observe at least some varatons; apparently, the changes n the composton of the GC mposed by the rotaton model are once more once less favourable to the EB at the consdered ponts n tme. In Fgure 4, the changes of the power ndex of Germany n the scenaro wthout agenda-setter take the opposte drecton. In month 2, Germany dsposes about 2 percent of the power and 3 percent n month 3. In month 4 ths value les at about 2 and at ca 3 percent n month 5. If the EB takes the part of the agendasetter, Germany has a power ndex of 0.2 to 0.3 percent. Even f a downward tendency s vsble here t should not be over-nterpreted because the power values for all NBPs are lower than 1 percent n the agenda-setter scenaro. As a consequence, the dfferences between the ndces can only be very small. Notably, the NBPs have a smlarly small nfluence on the votng outcome, opposte to the EB s domnant poston. - Fgure 3 about here - - Fgure 4 about here - We have seen that Germany s nfluence has ncreased n value from month 2 to month 3. In order to analyse possble reasons for ths qute dramatc loss of power we also compare the dstrbuton of power across the NBPs for these two months. Fgure 5 summarses these