The History of the Bundesbank

Jakob De Haan

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781134604135
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

After fifty years the Deutsche Bundesbank - the central bank that dominated European monetary affairs - has stepped down to entrust monetary policy to the European Central Bank (ECB). This is the first research work to thoroughly explore the lessons to be learned from the Bundesbank by the ECB, in areas such as price stability and political interference.

1   Introductory remarks on 50 years of the Bundesbank

Lessons for the ECB

André Szàsz

After a most successful 50 years, at the prime of life, the Bundesbank ceased to be the dominant central bank in Europe. This would justify a highly laudatory obituary, but perhaps not in itself a full-day workshop in Amsterdam. That took place because we are taught that the Bundesbank’s demise will immediately be followed by its resurrection. Or rather, its spirit will enter a new body, one even better than the old, and will descend on eleven countries instead of one. Far be it from me to challenge that faith. I fully agree: this is how it should be! But will it? In order to be able to answer that question, we are about to look at the lessons that 50 years of the Bundesbank can teach us. And we should go into the question of why it is that the Bundesbank was accepted by the other countries as the model for the ECB.

The essence of the model, of course, is the legal obligation to pursue price stability as the primary objective, combined with independence from political instructions. Yet, I am not sure that this is what I should stress, if asked to indicate the single most important factor that ensures the Bundesbank’s relative success in maintaining price stability. Rather, I should stress the extent of acceptance, on the part of the public and therefore of politicians, of price stability as the primary objective of monetary policy. Without that consensus, I am not sure that the Bundesbank model would have worked as it did in Germany.

Even the most successful central bankers are not born that way. And that also applies to their institution. The Bundesbank had to earn its credibility, earn its success, and earn its independence. The clash with Adenauer over interest rates comes to mind in this connection. Less often mentioned, but perhaps not less important, though less well understood, was the clash with Helmut Schmidt over the European Monetary System (EMS). In 1978, President Giscard d’Estaing of France and Chancellor Schmidt agreed that France would resume participation in a European exchange rate arrangement, after having felt compelled to suspend its participation twice due to lack of convergence. In order to avoid a third failure, Giscard insisted that the new mechanism should be fundamentally different from the earlier one. The burden of adjustment should be shared more ‘symmetrically’ in the new EMS than was the case in the old snake arrangement. The surplus countries – notably Germany – should assume a larger part of the burden. Schmidt agreed for political reasons. Later, it became widely believed that the Bundesbank had opposed the EMS but was forced to yield by Schmidt, who threatened to change the Bundesbank law. This is a myth. What the Bundesbank opposed – with strong support from the Nederlandsche Bank – was not the EMS as such. Both banks attached great importance to stable exchange rates with their main trading partners. Both deplored it when some countries no longer felt able to live up to their commitments and chose to leave the snake, but such countries were welcomed back when they felt they could do so again. What was rejected was the proposal to replace the simple and tested intervention mechanism of the snake by a highly complicated and hardly viable political concoction based on the European Currency Unit (ECU), intended to force the Bundesbank to assume additional obligations and thus to pursue more expansionary policies. The Bundesbank received sufficient domestic support to resist the pressure successfully. The EMS as it finally took shape was made to look as different as possible from the snake, but, in fact, it was not.

Helmut Kohl, who as the leader of the Christian Democratic Union/Christian Social Union (CDU/CSU) opposition had joined popular support for the Bundesbank, as chancellor pursued monetary integration with no less zeal than his predecessor. But in doing so, he was far more cautious when dealing with the Bundesbank. True, on German unification, he abandoned caution when determining the conversion rate for east marks, and when allowing the fiscal deficit to soar to some 5 per cent of the gross domestic product (GDP). But he acquiesced to the resulting interest rate increase without pressuring the Bundesbank to push rates down, in spite of the pressure from all other EU governments to do so.

Thus, the political pressure on the German government to force the Bundesbank to push down interest rates did not work. This, more than anything else, induced the French government in 1988 to revive the issue of a European Central Bank, implying the transfer of monetary decisionmaking from the national to the European level. The Delors Committee was asked to make proposals to that end. Its chairman, Jacques Delors, understood that it could have an impact only if it would be unanimous, and that it could be unanimous only if an ECB based on the Bundesbank model would be the core of the report. Only Delors, with his influence in Paris, could have produced such a report.

The currency crises of 1992 and 1993 seemed to darken the EMU’s prospects, even though the Maastricht Treaty had been signed by then. If countries that were participating in the EMS were not able to make a system of stable but adjustable central rates work, then, it was asked, how could they meet the far greater demands of a single currency? In fact, the currency crises probably increased, rather than decreased, French determination to pursue EMU, for they demonstrated that – since floating is no option for the open, interdependent continental economies – its alternative would be a German mark bloc. In such a bloc, the Bundesbank’s policy, decided on the basis of German priorities and of circumstances that prevailed in Germany alone, determines the monetary stance in the European Union as a whole. This was not acceptable to France.

For France, the main importance of EMU is that monetary policy is no longer, in effect, imposed on it by the central bank of another country, but decided at the European level. For this, it had to pay a price: the ECB’s independence. France did not hide the feeling that this was not a preferred outcome. In 1988, Edith Cresson – who was, at the time, Minister for European Affairs – expressed her misgivings in an interview with Le Nouvel Economiste in her inimitable way. The Bundesbank, she said, was imposed by the victor on the vanquished after the war, and that could be no reason for Europe to adopt this model. Mitterrand, Chirac and Jospin shared her feelings. Mitterrand, on one well-publicised occasion, even denied the ECB’s independence, and on an other occasion – this time closer to the truth – referred to it as a sacrifice that had to be made for Europe’s sake. But did not this sacrifice, by preventing the French government from influencing the ECB’s policy, defy the EMU’s purpose as far as France is concerned?

Even if this is so, contradictions are not limited to the French side. Germany, the only country really giving up monetary autonomy, was in a position to insist on the ECB’s independence as a condition for EMU. But Germany realised that statutory independence, though crucial, is not sufficient. It does not work, in practice, if the mix of monetary and fiscal policies becomes too unbalanced. Excessive public sector deficits will force up interest rates, and these high interest rates will be blamed not on the government, but – as experience shows – on the central bank. The ECB will then come under political pressure. To prevent this, Germany – strongly supported by The Netherlands – insisted on the obligation for participants to avoid excessive deficits, and made its intention clear to interpret this strictly, on the basis not of plans but of proven stability. By now, we know that this strictness is flexible.

What are the prospects that the ECB will function in the EMU as the Bundesbank did in Germany, with policies that result in a stable euro? As far as this depends on the ECB’s statute, the prospects are bright. But other questions are also relevant:

•   Is there a consensus on price stability in the EMU comparable to the consensus that played a decisive role in Germany?

•   Is there a consensus on the ECB’s independence?

•   Will the EMU be sufficiently homogeneous to make a ‘one size fits all’ monetary policy acceptable?

No other country in Europe has had Germany’s traumatic experiences with inflation and its aftermath, experiences that have penetrated deeply into national memory. Therefore, consensus on price stability cannot possibly be comparable. Whenever economists in The Netherlands – which is, in currency issues, closest to Germany – publish anti-EMU manifestos, their worry, unlike the worry expressed in German anti-EMU manifestos, is not about inflation but about deflation. Whether consensus over price stability will develop over time depends on the tensions that the EMU will have to go through.

These tensions are likely to be stronger the less homogeneous the EMU turns out to be. This was the reason for Germany, supported by The Netherlands, to insist on the convergence criteria in the Maastricht Treaty and on their strict interpretation. The watering down of these strict criteria is likely to have consequences for the functioning of the Stability and Growth Pact and for the ECB.

The Stability and Growth Pact is an essential element of the EMU. Unlike the way it was originally proposed, it is not automatic. Severe sanctions can be imposed in case of excessive deficits, but only if the required qualified majority can be mustered. If it works in practice, it will work by prevention rather than by cure. Is it likely to work? Even in the main core countries, prospects for achieving the agreed – and indispensable – further deficit reduction towards equilibrium are uncertain. Are we ever likely to raise the qualified majority needed to fine a non-complying country, when even the blocking minority required to keep one out cannot be mustered?

What does this mean for the ECB? A ‘one size fits all’ monetary policy for a large, diversified area is likely to face problems under the best of circumstances. As it is, some central bank governors will be aware that every percentage point interest rate increase means a 1 per cent increase in the public sector deficit in their own country in view of its debt ratio of 120 per cent. This might not deter them from an agreement to raise interest rates if price stability is clearly at stake. But it never is, until it is too late. Timely decisions are always made when there still is some uncertainty about whether this is really inevitable. If, at the same time, the effect on the deficit in some countries, with all the resulting problems, is certain, the temptation to argue for postponement will be strong. Delaying interest rate increases and accelerating cuts is precisely what makes the difference with a policy that gives priority to price stability. Thus, diverging interests of participating countries can hardly fail to be reflected in the ECB, dividing it and preventing it from becoming the strong institution that some of us intended.

I should like to add two observations from my own experience of how central bank policy is made in practice. First, central bank policy is not made by declarations of intent. Policy emerges from series of routine decisions. Each of them might have been different without making much difference. Taken together, they determine the policy stance.

Second, in the past, the policy decisions of the EMS countries other than Germany were relatively straightforward. The EMS required priority for the exchange rate over other considerations. This reduced the scope for discretion. In the EMU, this will be very different. The euro area is a relatively closed economy comparable to the USA. Policy decisions will be made on the basis of domestic considerations. For some, this is precisely why they wanted to establish EMU. European central bankers who have acquired a reputation of monetary strictness have, in a number of cases, done so because they accepted external discipline, making a virtue out of necessity. In EMU, they will find themselves in a completely new situation: strictness will no longer be a necessity. Whether it is a virtue will then be disputed.

Economic and monetary union is a unique political enterprise. As such, it carries risks as well as opportunities. I stressed the risks partly because politicians seem to have no doubt at all that it will be a success, that the ECB will be a strong institution and the euro will be a strong currency. I do not know, and neither do they. There is nothing automatic about it. Success has to be earned, as it was by the Bundesbank. The ECB’s task will be easier in some respects, and more difficult in others.

It will be easier because of the Bundesbank’s success. I do not mean that this success will be inherited – acquired characteristics can never be inherited. But it has made price stability and central bank independence more respectable, more politically acceptable – perhaps more fashionable, but fashions sometimes change – than was the case when EMU was first announced as an objective. There was no word on central bank independence in the 1970 Werner Report!

The task will be more difficult because of the EMU’s diversified composition and the participating countries divergent political motives. The Bundesbank has over the years carefully built up its credibility, and this was a crucial part of its success, enduring the strains of unification. The ECB will have to build up its credibility if it is to be comparably successful. In doing so, it will face governments’ inclination to shrug off constraints when these become bothersome. We have seen this in the question of convergence criteria, as well as where the term of office of the president of the ECB is concerned. A central bank’s credibility is determined, in part, by how it reacts to such efforts. National central banks like the Bundesbank and the Nederlandsche Bank cannot bequeath their tradition in this respect to the ECB, but they will maintain an important role in keeping in touch with their own politicians in order to convince them to respect the rules. Whatever misgivings some of us may have, once EMU starts it must become a success, and this will be the case only if participating countries respect the Maastricht Treaty and fulfil their obligations. This will be the case only if both the ECB and the partner countries keep insisting that the objectives are maintained. From a monetary point of view, we are becoming each other’s interior. Intervening in what used to be the other’s internal affairs is now an indispensable part of a single currency. Far from being ‘non-communautaire’, it is required to make EMU durable.

2 How independent is the Bundesbank really?

A survey

Philipp Maier and Jakob de Haan

2.1 Introduction

The Deutsche Bundesbank is widely regarded as being one of the most independent central banks. Eijffinger and de Haan (1996) provide the ranking of the Bundesbank according to a number of measures of legal central bank independence, which are all based upon the statutes of the central banks. Although the ranking of central bank charters by their degree of legal independence is a difficult task that involves some subjective judgement, it is remarkable that all proxies for legal independence yield the same outcome for the Bundesbank. Nevertheless, it is unclear whether formal independence also guarantees de facto independence. Forder (1996: 43–4) argues that ‘a central bank may be independent by statute, and it is nevertheless accepted – on all sides – that the government will have its wishes implemented. … it is quite clear that the reading of statutes is not a measure of independence in the sense required by the theory …. There is no theory that says it matters what the rules say. There is only a theory that says it matters what the behaviour is.’ Of course, one could conjecture that the statutes of the central bank may (at least partially) shape the options for the central bank to pursue the kind of policies that he or she deems necessary.¹ Still, one might wonder whether the members of the Bundesbank Council have indeed always been politically neutral technocrats with a strong esprit de corps as Marsh (1992) claims. However, even if they are not, the German public clearly has high esteem for the Bundesbank. A survey of a German research institute on attitudes towards public institutions reflects a high level of trust by the German population in both the Federal Constitutional Court and the Bundesbank (which score 2.2 and 2.1, respectively, on a scale of 3). This compares favourably with the scores of the federal government (0.6) and the lower house of parliament (0.9), respectively.²

The literature has identified two main approaches to examine whether the government’s preferences with respect to economic policy affect central bank behaviour:

• Direct influence may force the central bank to alter its policy according to the wishes of the government.

• The government might exercise indirect influence through fiscal policy. Of interest is the extent to which the government budget deficit is accommodated by monetary policy.

If governmental influence is not observed through either of the two channels, then we might conclude that a central bank operates independently of the government. However, reversing this reasoning does not hold, as Lohmann (1992) notes. An independent central bank may create political business cycles if, for partisan (or other) reasons, it would like to influence the chances of re-election of the incumbent government. So, if we observe an electoral cycle in monetary policy, it is unclear whether this is due to a dependent central bank that is following the wishes of the government, or due to an independent central bank that is trying to influence the election outcome in a certain direction.

This chapter critically reviews existing research on the government’s influence on Bundesbank policies. The chapter is organised as follows. The next section describes Germany’s institutional setting. Section 2.3 summarises relevant theories. Section 2.4 provides some considerations that we think are relevant for all studies. Section 2.5 surveys studies that capture direct influence, while Section 2.6 reviews studies that concentrate on indirect influence. Finally, Section 2.7 offers our conclusions and outlines some alternative methodologies and suggestions that could be used in future research on the Bundesbank or the ECB.

2.2 The institutional setting

A serious drawback of various studies (especially if they do not focus exclusively on Germany) is that the author(s) do not take into account particularities of the German institutional setting. This shortcoming is most apparent in cross-country studies where ‘one model fits all’...

Table of contents

• Front Cover
• Half Title
• Routledge International Studies in Money and Banking
• Title Page
• Copyright
• Contents
• List of figures
• List of tables
• List of contributors
• Preface
• Introduction by Jacob de Haan
• 1 Introductory remarks on 50 years of the Bundesbank: lessons for the ECB
• 2 How independent is the Bundesbank really? A survey
• 3 The Bundesbank’s reaction to policy conflicts
• 4 From low inflation to price stability in Germany: measurement, costs and benefits
• 5 Credibly conservative monetary policy and labour–goods market organisation: a review with implications for ECB-led monetary policy in Europe
• 6 Monetary policy of the ECB: Strategy and instruments
• 7 The European Central Bank as a new institution and the problem of accountability
• Index