La Deutschmark Vita

by Henry on June 6, 2009

This FT article is the best piece I’ve seen on the intra-Europe battles over ECB policy, but it could go deeper still.

When Angela Merkel ended a long and otherwise unremarkable speech about economic policy this week with a vitriolic attack on the world’s three mightiest central banks, the German chancellor was writing a minor chapter of her country’s political history. No previous chancellor had dared attack their, and others’, central banks so frontally – saying the US Federal Reserve, Bank of England and European Central Bank should all row back on their unconventional recent ways of propping up economies. …

Ms Merkel broke a cardinal rule of German politics – that a chancellor should never discuss, let alone criticise, monetary policy. … Few principles of economic policy are as sacrosanct in Germany as central bank independence, which has its origins in the 1923 hyperinflation that wiped out the savings of millions of Germans … for the country’s postwar rulers the lesson was that inflation had to be kept at bay by an independent central bank that would focus on nothing else. It was a condition of Germany adopting the euro that the ECB should be made in the Bundesbank’s image – independent, focused on price stability and even Frankfurt-based.

… On a more tactical level, Ms Merkel was not so much trying to influence monetary policy as taking sides in an internal debate at the ECB. Government insiders say Axel Weber, president of the Bundesbank and one of the chancellor’s most trusted economic advisers, had complained to her about the covered bond purchase, which he opposed. Like the chancellor, Mr Weber sees the move, a small step towards quantitative easing, as a concession by Mr Trichet to economists and others who think the ECB has been too timid in its crisis management, say people close to Ms Merkel.

As the article says, the ECB was supposed to be the Bundesbank writ large, with the same strong anti-inflationary bias. The German government had enormous bargaining power vis-a-vis France etc when the ECB was being designed, because the Bundesbank already more or less set French (and Irish, and …) monetary policy anyway. But there was one institutional design feature that the Germans did not push for, surprisingly (I have never read a good explanation for why). Germany accepted a one-state, one-vote arrangement in which Germany had no more direct power over ECB policy than any other state (indirect power was a different matter of course …).

And that is why we saw Merkel’s speech last week. As long as the political pressures weren’t too great, anti-inflationary policy and political independence went hand-in-hand, as far as Germany was concerned. When the French started making noises about the problems of the ECB’s one-size-fits-all policy, the Germans could wax indignant about central bank independence, and shut them up. But now that the ECB is in a crisis, where there (a) are real disagreements about how to proceed, and (b) some of the options receiving serious discussion go against Germany’s strong preferences, Germany is finding that it has to compromise the principle of central bank independence in order to try and make sure that the Bundesbank follows its preferred course, rather than drifting along down the path of quantitative easing.

The problem is, of course, that this weakens Germany’s position in the long run. Germany would greatly prefer a European central bank which pursued anti-inflationary policies and retained its independence, to one where anti-inflationary policies become the subject of political bargaining, even if, most of the time, Germany will prevail in the bargaining process. This explains Merkel’s peculiar coyness – making a major policy statement which is intended to fire a shot across the ECB’s bows – but also downplaying it in various ways. The last thing that Germany wants is for ECB policy to be set through duelling communiques from leaders of major European states. But whether Germany wants it or not, it is going to get it, at least to some limited degree – it has set a significant precedent here that it will have enormous difficulty in walking back. The next time that Sarkozy starts making public pronouncements about the problems of ECB policy, it will be much more difficult to shut him up.

{ 18 comments }

1

hidflect 06.06.09 at 7:00 pm

Max Keiser mentioned this also. But the MSM? They don’t report anything that disturbs the status quo. But recently they’ve caught on. They DO report it sometimes now… in the same bland monotone as the rain forecast for Moscow and so they say; “See!? We do our job! The viewer is just uninterested!” Maybe it’s true, but it’s disingenuous…

2

bert 06.06.09 at 8:21 pm

Of course, Germany has been in breach of the Stability and Growth Pact since forever.
Hasn’t stopped it being a firm enforcer of the Maastricht orthodoxy. Or from squashing other proposals that might be grouped together under the heading “crass Gaullism”. Perhaps a conclusion from recent experience: Germany will continue to get its way inside the eurozone unless at the same time the US is putting its thumb on the scales.

I take your point that ritually invoking central bank independence may be rhetorically ticklish in the future. But I’m not sure that translates into a victory for advocates of “economic government”. French complaints about the ECB arrangements consistently came down to whinging about how difficult it had become to use monetary policy to goose growth. German opposition to that sort of thinking lay behind Merkel’s outburst, and will continue to hold sway in internal eurozone discussions.

3

mpowell 06.07.09 at 9:09 am

Somehow I think Germans obsession about inflation is a means of blaming Nazism on the hyperinflation preceeding it. This would be wrong, of course, as would thinking that hyperinflation was the worst economic problem Germany faced pre-war. This is probably unfair, but it remains the case that a little bout of inflation is not the most dangerous thing at the moment economically. (don’t Germans have defined benefit social security plans- how is inflation that devastating to them anyhow?)

4

Jon Livesey 06.08.09 at 12:03 am

“Somehow I think Germans obsession about inflation is a means of blaming Nazism on the hyperinflation preceeding it.” – or of blaming it on the allies who are blamed for the hyperinflation?

In addition to the very good points made by mpowel, maybe we should note two things. First, calling something a “lesson” is a bit tendentious. Nations and individuals learn neurotic lessons as well as rational ones, and the German obsession with inflation refers back to events that are nearly ninety years old. Second, hyperinflation wasn’t some sort of natural phenomenon, but the result of deliberate German Government policy. If Germans are concerned about inflation, the answer is simple: “Don’t do that”.

5

StevenAttewell 06.08.09 at 5:02 am

The problem is, of course, that this weakens Germany’s position in the long run. Germany would greatly prefer a European central bank which pursued anti-inflationary policies and retained its independence, to one where anti-inflationary policies become the subject of political bargaining, even if, most of the time, Germany will prevail in the bargaining process.

Well, I guess the question is which the Germans want more – a European Central Bank that’s independent or a European Central Bank that’s anti-inflationary. Seems to me that a big part of the problem is that the ECB’s policies are violating part of the unspoken compact of central banking – Independence in return for nonpartisan expertise – by pushing a policy that virtually every other player in the process thinks is insane. The smart thing to do would be to “switch in time to save nein.”

6

Zamfir 06.08.09 at 8:10 am

You can easily put too much emphahisis on “fear for hyperinflation” . It’s just as much the case that Germany has fared very, very well in the last 50 years under the low-inflation regime. What the Germans fear is probably less 1920’s German inflation, and more post-war Italian inflation.

7

Tracy W 06.08.09 at 8:40 am

This would be wrong, of course, as would thinking that hyperinflation was the worst economic problem Germany faced pre-war.

Why would it be wrong to think that hyperinflation was the worst economic problem that Germany faced pre-war? I’m genuinely curious here. I know that Germany had other serious economic problems, eg the reparations, the Great Depression in the rest of the world from 1929, but I am interested in what ranking mechanism you are using to say that those other problems were greater.

8

novakant 06.08.09 at 9:51 am

a little bout of inflation is not the most dangerous thing at the moment economically.

I’m not an economist, but wasn’t a major reason for the current economic crisis the UK/US nonchalance about spending money you don’t have, embraced both by the respective governments and individuals. And isn’t printing more money just another way of spending money you don’t have?

9

mpowell 06.08.09 at 10:56 am

Re: 7, this is really a cop-out, but I would really just like to bring attention the point that I have seen this argued before and I am no expert on the issue personally. The account I read claimed that for the agricultural class hyperinflation was better than what it took to bring inflation down. Also, notably, it was only after the end of hyperinflation and continuing economic malaise that the Nazi party was able to come to power, which is I think the more relevant, and stronger, point.

Re: 8, I think you are oversimplifying the situation greatly. There are many ways to make the argument that during a recession, deflation is a much greater concern than inflation. Let me try to make the point this way: the goal of a central bank it to keep the money supply more or less constant. Prices are sticky so this is pretty important. The problem with a recession is that people are unleveraging positions which are shrinking the effective money supply. The resulting distortions are relaxed with some inflation as opposed to deflation. I don’t think talk of spending money you don’t have is very accurate. The reason why is that we are concerned with increasing unemployment, which in addition to increasing human misery also leads to less production in the overall economy. This unused labor force represents lost potential wealth. So policy intended to correct that is definitely not try to ‘spend money we don’t have’, but trying to get what we do have working as optimally as possible.

10

Квартира в Праге 06.08.09 at 11:32 am

We won’t see our money anymore. Just take it as is and leave your hopes! It’s not a Europe I want to live in.

11

JoB 06.08.09 at 11:44 am

Could somebody post on the European election only pan-European effects: low turn-out and a steady decline of the left wing?

12

novakant 06.08.09 at 12:38 pm

The problem with a recession is that people are unleveraging positions which are shrinking the effective money supply.

That is one of the problems with a recession, people are holding on to their money and investing more conservatively. But in the long run, I would say this form of behaviour is actually very commendable – especially since the current crisis has been caused by irresponsible lending and borrowing practices. And aren’t we effectively punishing the people who have handled their money responsibly, by lowering interest rates and making money worth less by increasing the supply?

13

mpowell 06.09.09 at 9:22 am

12: Well, there’s no good way to address this. It would be nice to reward people who have behaved responsibly, but a shrinking money supply really screws up the economy. Is that worth having lots of productive people thrown into unemployment? I think the consensus is that it’s better to avoid that, if possible.

14

stostosto 06.09.09 at 11:43 am

I think Zamfir #6 is spot on.

The post-war Wirtschaftswunder, perceived to be built on the strong and stable D-mark, is a huge source of national pride in a country that lost most other such sources in 12 short insane years.

15

StevenAttewell 06.09.09 at 3:25 pm

Novakant:

What you’re describing is known as the “paradox of thrift.” And I don’t think it’s more responsible when it collectively leads to recession and unemployment – it’s not really being driven by some underlying virtue of probity, but rather by an irrational fear of losing everything, akin to a run on a bank.

The other option is to punish the entire economy by prolonging a recession.

16

Myles SG 06.10.09 at 10:37 am

“Perhaps a conclusion from recent experience: Germany will continue to get its way inside the eurozone unless at the same time the US is putting its thumb on the scales.”

That would be just be absurdist theatre; Deutschland has had better credit scores than Amerika since like forever. America trying to toy around with European monetary policy, at this (late) point in the game, would be kind of like the barbarian playing with the governance of the Roman fort.

17

Danb 06.10.09 at 12:04 pm

I see two driving forces calling for a macroeconomic overhaul: 1) Bad Money (from author Kevin Phillips), which refers to the out of control and destructive effects of finance –which is a necessary sector but cannot produce significant value and wealth in a modern society- and the Bottleneck of ecological circumstances (outlined by E.O. Wilson). Bad Money could lead our governments into insolvency. The Bottleneck ecological issues are largely hidden but very much intertwined with Bad Money. The most economically pressing ecological condition is that a plateau in crude oil production was reached about four years ago. This contributed to the economic crash of last summer. In effect, the geological limitation on oil production virtually guarantees a return to limitless economic growth is no longer possible.

18

bert 06.10.09 at 2:42 pm

Myles@16 –
Don’t get me wrong, I don’t think toying around with European monetary policy is as easy as all that. There’s a formal independence unequivocally granted to the ECB:

Neither the ECB nor the national central banks, nor any member of their decision-making bodies, are allowed to seek or take instructions from European Community institutions or bodies, from any government of an EU Member State or from any other body. Community institutions and bodies and the governments of the Member States must respect this principle and not seek to influence the members of the decision-making bodies of the ECB (Article 108 of the Treaty)

Of course, that’s de jure independence – but it’s also held up solidly in the real world.
What’s the source of the US pressure? The role assigned to central banks in the crisis measures adopted by the Anglo-Saxons (unorthodox measures, quantitative easing, etc) and the demand that this approach be part of a common front that includes the ECB.
The pressure’s been applied formally and informally through international forums and bilateral contacts, and has been partially successful in overriding internal resistance from German voices inside the ECB. The policy outcome we’ve seen is the result of an internal debate inside the ECB Governing Council, conducted very roughly along Krugman vs Ferguson lines.

Henry’s suggestion is that the public display of frustration by the German government will imperil central bank independence in Europe, assist the longterm Gaullist project of politicising monetary policy, and likely push policy outcomes away from the anti-inflationary purist end of the spectrum.
My scepticism draws in part on the observation that German politicians have for years run an “excessive” debt-to-GDP ratio without damaging the consensus arrangements agreed (at German insistence) at Maastricht.
Nobody plans for the current unorthodox measures to be anything other than a temporary expedient, the consequences of which will need to be unravelled over time. Once more normal conditions return, treaty-enshrined independence and a clear anti-inflationary mandate will remain intact.

That said, if we get a nasty double-dip, things may fall apart in all kinds of unpredictable ways.

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