The Central Bank as an Organism: Culture as an Engine of Behavior

External adaptation, in a biological sense, is the ability for an organism to acclimate to its surroundings; organisms develop certain features or skill sets that allow them to survive and thrive in a given environment. Adaptability, thriving and surviving are also traits of businesses, universities, the government, etc.

The overarching goal for businesses, for example, is to sustain value by maintaining a competitive advantage, something that is usually ingrained into its culture (mission statement, values, etc.).  For government entities, cultural values include, at least in democratized societies, societal improvement and the protection of national assets.

Culture has an important role in shaping adaptability, as it establishes the foundation for certain norms or the “manifest of behavior, between-individuals behavioral consistencies” (Dalkir 226).  Culture heavily influences to what extent certain businesses manage and tolerate risk, and an important consideration for the differences in world governments’ responses to fiscal problems (an example being the Eurozone crisis). Broadly, culture can also influence the sharing of knowledge, such as the tendency for groups to freely allow (and likewise restrict) the flow of information in an organization.

There thus exists a parallel process or synergy between the managerial and policy aspects of central banking, ranging from how psychology influences decision making or when organizational structure influences policy. This post will explore two principal findings from this research: how culture is an integral part of central banking, and how psychology influences culture and thus affects central bank behavior.  In addition, this post will also illustrate the primary difficulty involved with this research, what was learned, and any future applications of this work.

These internal and external mechanisms are the primary catalysts of organizational activity, whether it becomes a driver for a business transaction or the basis of a policy decision.  It is thus crucial to understand how culture affects the overall organizational framework, especially high-profile institutions that have direct societal impacts, an important one being the central bank.

For a central bank, the only observable manifestation of central bank culture and its relationship to adaptability to learning and communication may be in the area of central bank governance. Previous studies in organizational culture point towards an “idealized” culture that “[fosters] open learning” (Momani and Amand 7) as it encourages collective participation.  In other words, previous literature suggests that an underlying implication of central banks that lack an open learning culture also lack participatory dialogue and are threatened by a mismatch of strategic vision.

Principal Findings

Central bank culture can be dissected externally, as policies are consistently “determined by the surrounding legal framework defined by the government and the business environment” (Mooij 5). The business environment is representative of all the environmental conditions that a central bank is directly influenced by.  Some examples of these are regulatory legislation passed by government, overall firm behavior in the financial industry, or simply economic factors. Central banks have a highly symbiotic relationship with the business environment: while they monitor any changes in national markets, they can also affect markets directly by stimulating economic activity or not (most notably through the control of short-term interest rates).  The dynamic, two-way influence of the business environment on central banks thus dictates the bank’s culture, whether that is in relation to how the central bank tolerates risk, manages uncertainty, or forecasts conditions.

Inflation, for example, has a profound influence on what instruments central banks use in order to correct an economy. When inflation is the primary problem in an economy, it “causes policymakers to become less confident in their ability to assess the stance of policy.” As a result, central bankers utilize money targets as “signals of monetary authorities’ intention to get tough on inflation” (Bernanke & Mishkin 4). This is elucidative of two things: that 1) central bank culture is particularly susceptible to inflation that then influences a culture of crisis-driven policymaking and 2) that culture is influenced by public perception; central banks signaling through money targets “help the bank both to manage the public’s expectations and to defend its policies against political pressures for more expansionary policies” (Bernanke and Mishkin 4). These two points underscore the importance culture has in central bank decision making, as it becomes apparent that not only is the bank concerned with the economic engine of a national and global market but also how the public perceives them as an aggregate, a nod to a culture of transparency and accountability — a principal value of many societal institutions.

Because psychology affects behavior and behavior affects culture, psychology is another medium that can be tapped into to further understand cultural dynamics. The best way to understand economics through a psychological lens is through behavior economics, which in many ways is a subset of psychology itself. It would also be helpful to understand from a situational perspective.

The period before the Financial Crisis of 2008 was called the Great Moderation.  It was a period in which the global economy experienced relative stability in terms of growth, banking, and inflation; there was a broad understanding that “central banks… had moderated macro-economic undulations” and that “financial innovation, while not eliminating risk, scattered it to the four winds” (Haldane 2). The economy’s players and regulators were accustomed to positive conditions in such a way that they discounted risk, “[underlining] the importance of cognitive constraints on decision-making when assessing the robustness of policy” (Haldane 2).

A foundational aspect of these cognitive constraints is the principal agent dynamic, which is when “society delegates [policy] choices to an individual or set of individuals, often either politicians or bureaucrats” (Haldane 3). The principal-agent dynamic is particularly influenced by preference biases, whereby “the agent may have preferences which are not perfectly aligned with society at large.”  This is caused by a variety of factors, such as “autocracy” as well as “corruption” (Haldane 3) that then causes preferences to become misaligned. The psychological value of these finding stems from how certain behavioral biases can negatively (or as a corollary positively) impact behavior since these biases can be looked into as sources of problematic decision making and cultural frameworks.

Difficulties

The most difficult aspect of this project was the limited literature on this subject, in terms of specific articles that explored central bank culture.  However, there are many resources on subjects like managerial structures and corporate culture and thus in order to working around this difficulty involved translational research.  That is, finding literature and then applying it to the subject matter.  For example, even though an article on organizational structures did not address any central banking implications whatsoever, the knowledge gained from the article can be used in order to make hypotheses and recommendations.

Learning Outcome

The purpose of this project, as stated in post 1, is to comparatively synthesize currently available information regarding the organizational culture of central banks, their learning systems, and communication dynamics.  While there is still so much to be learned, through this research we get a better understanding of how a central bank operates and how cultural, psychological, and organizational aspects are at play and ultimately drivers of decision making. It provides a springboard of ideas and hopefully acts as a catalyst for specific recommendation to combat psychological bias and cultural lags, among others, to contribute to more sound policy decisions.

Future Applications

The next phase of this research would involve applying the principles learned in this research to creating a sound policy and organizational model.  Statistical analysis such as a regression model would be heavily utilized in order to establish/elucidate patterns and then apply them for specific recommendations. Simply put, future applications of this research would explore even deeper into this subject with the intent of creating a framework for change.

Deconstructing Central Bank Culture, Communication and Behavior

Organizational culture is a multidisciplinary topic, touching on a variety of subjects such as organizational psychology, regulatory law, sociology, management and economics. Edgar Schein, regarded as the pioneer in organizational psychology and culture, defines organizational culture as “a pattern of basic assumptions—invented, discovered, or developed by a given group as it learns to cope with its problems of external adaptation and internal integration—that has worked well enough to be considered valid, and, therefore, to be taught to new members as the correct way to perceive, think and feel in relation to those problems”.

The purpose of this project, as the title suggests, is to comparatively synthesize currently available information regarding the organizational culture of central banks, their learning systems, and communication dynamics with the purpose of unifying this information into a singular body of work—something that has not been done as of yet.  The proposed second phase of this project will be focused on its application, which will work towards creating an organizational model that could be applied to central banks using statistical techniques.

This project’s primary objective is to elucidate the various implications central bank culture, communication and behavior have on the strategic decisions a central bank makes.  This research will also look into how organizational structure directly influences the decision framework of a central bank, in conjunction with the managerial properties of the organization.

The methods that will be incorporated in this research is an in-depth literature review covering multiple subject areas such as regulation, economics, sociology,  politics, etc. Other mediums will also be analyzed like central bank press releases, such as those published by the Federal Reserve.  The language and content of these press releases are indicative of organizational culture (i.e. technocratic, transparent). This study will also look at literature exploring central bank psychology, an example being various biases in decision making and the different behavioral patterns exhibited by central bank staff. Cases will also be utilized such as the Moroccan Central Bank and other global monetary authorities.

This project is both economically and managerially significant as it will evaluate best-practices and use them to create a functional model that would act as a catalyst to more sound policy choices and decision making in central banks.  What this project hopes to achieve is a much deeper understanding of how organizations adapt and evolve, like organisms, in an ecosystem of dynamic change and how certain improvements can be made such that the endogenous factors of decision-making influence exogenous change.