Published by EH.NET (August 2001)
Jakob de Haan, editor, The History of the Bundesbank: Lessons for the European Central Bank. London: Routledge, 2000. xiv + 161 pp. $90 (hardback), ISBN: 0-415-21723-7.
Reviewed for EH.NET by Hans-Joachim Voth, Department of Economics, Massachusetts Institute of Technology.
Few institutions vanish at the height of their powers and reputation. The Bundesbank, however, was one that did. In the early 1990s, Financial Times journalist David Marsh argued that it had “replaced the Wehrmacht as Germany’s best-known and most feared institution.” The Bundesbank’s demise as a policy-making institution marks a sharp discontinuity in the continent’s post-war economic history. On January 1, 1999, with the introduction of the Euro, the baton for setting interest rates in Europe passed to the European Central Bank (ECB). A number of volumes have consequently tried to capitalize on a bit of early nostalgia — a massive edited volume, put out by the bank itself, on Fifty Years of the Deutsche Mark (Oxford University Press, 1999), most prominently amongst them.
The volume edited by Jakob de Haan is the result of a workshop at the Germany Institute in Amsterdam in April 1998. While this is a fine contribution to contemporary debate on monetary policy, containing many valuable pieces of scholarship, one thing must be clarified at the outset — this is not a history of the Bundesbank, let alone “the” history of the Bundesbank. The contributors provide a number of comparisons between the ECB and the Bundesbank, and examine Bundesbank policy in the recent past with a view to deriving lessons for ECB policy. This is a thoroughly worthwhile exercise, and it is a pity that the publisher or the editor has decided to shun truth in advertising by picking such an embarrassingly grandiose title (perhaps to justify the obscenely high price?). Readers interested in an historical account of the German central bank’s policy should turn to the Fifty Years of the Deutsche Mark mentioned above.
What, then, are the lessons that the ECB should learn from the Bundesbank? In terms of its institutional setup, the similarities are striking. As Sylvester Eijffinger shows in his detailed and eloquent contribution, the Bundesbank and the ECB achieve almost identical scores for independence. In terms of transparency and accountability, however, both do worse than the Fed, the Bank of England, and the Banque de France. Neither publishes minutes of its meetings. Also, in terms of policy instruments, the long shadow of the Bundesbank clearly influenced the ECB. Minimum reserve requirements feature prominently in the bank’s arsenal of policy instruments, and money growth targeting (while not as central as with the Bundesbank) plays an unusually large role. Eijffinger argues that, despite these numerous similarities, the ECB may have a hard time earning a reputation on par with the Bundesbank. This is because legal independence is not enough to guarantee de facto autonomy in setting interest rate policy — cultural and social factors play an important role as well. This concern is echoed in Otmar Issing’s concluding comments, too. Acquiring a reputation requires inflicting a bit of pain in hard times, or so Eijffinger argues. The true test will only come when politicians and central bankers start to argue.
From the perspective of 2001, many of these caveats seem prescient. Also, the simple day-to-day management of central bank policy turned out to be more of a challenge for the ECB than many had expected. From the regular gaffes of its president Duisenberg to the general and mounting skepticism about the common currency in foreign exchange markets, the ECB has had a hard time filling the Bundesbank’s boots. Recent Italian attempts to tinker with the so-called “stability pact” (that limits member states’ deficits) reinforces the importance of Eijffinger’s point about the importance that legal independence may not be enough.
Given that inflation today throughout Europe (with the possible exceptions of Ireland, Spain, and Portugal) is still relatively low, why worry? Karl-Heinz T?dter and Gerhard Ziebarth, two economists at the Bundesbank, argue that only dead inflation is good inflation. Even low inflation of around two percent is, in their view, clearly dominated by price-stability. According to their calculations, these benefits are exclusively driven by consumption timing effects. Gross benefits might be as large as two percent of GDP, and the net effect could still amount to 1.4 percent. These results are for Germany, and it is somewhat disappointing that in a volume that aims to derive lessons for the ECB, no attempt is made to examine if the same results hold for the Euro area. Perhaps more worryingly, two standard objections to a policy of zero inflation — that this increases wage rigidity, and increases the likelihood of monetary policy being “trapped” because nominal interest rates cannot fall below zero — are dismissed too lightly. In a simple technical sense, the paper also falls short of the standards now common in the debate about monetary policy rules (for a state-of-the-art contribution, see David Vestin’s “Price Level Targeting versus Inflation Targeting in a Forward Looking Model” at http://rincewind.iies.su.se/~vestin/html/price.html).
In many ways, Helge Berger’s and Friedrich Schneider’s article on Bundesbank behavior during political conflicts is the most impressive contribution in this volume. It is very much part of a recent trend in the literature to examine empirically how much of the Bundesbank’s tough-guy rhetoric was justified, given its actual behavior. Jordi Gal?, Mark Gertler and Richard Clarida showed that, despite “officially” targeting money growth, the Bundesbank since 1973 largely behaved as if it followed a modified Taylor-rule, targeting inflation and — horribile dictu — output. Berger and Schneider examine if the Bundesbank really never blinked in the face of political adversity, as common wisdom has it. Given that its independence could be taken away by parliament, this would hardly have been an optimal strategy. Berger and Schneider define policy conflicts as those cases when money growth provided a stimulus to the economy that was the opposite of the fiscal stimulus. By this definition, the federal government and the Bundesbank were pursuing contradictory policies about every other year of the post-war period. Berger and Schneider find that, for a broad range of specifications and policy instruments, the Bundesbank proved more “accommodating” when the government in Bonn tried to steer the economy in a different direction. This is a very interesting finding that questions one of the most persistent myths about the Bundesbank. However, some of the details of the estimation only lend qualified support to this conclusion; other results are a little odd. Berger and Schneider’s estimates of the reaction function, for example, imply that the Bundesbank reacted only mildly and rarely significantly to increases in inflation, while targeting output very strongly. This is at variance with the findings by Clarida, Gal? and Gertler (European Economic Review 42, 1998), who demonstrated that the Bundesbank targeted inflation to a greater extent than the output gap.
Readers will fully appreciate the contribution by Berger and Schneider once they have read the literature overview by Philipp Maier and Jakob de Haan. There is a voluminous literature on the extent to which the Bundesbank really was independent. Empirically sound analysis seems largely conspicuous by its absence, and much remains to be done until we know as much about direct and indirect political tinkering with monetary policy in Europe as we do about the Fed.
This edited volume contains good research summaries. Graduate students and researchers will find much that is of use, and some of the articles are important contributions in their own right. At the same time, crucial policy questions such as the possible adoption of inflation targeting by the ECB are never fully discussed, and it is difficult to claim that these seven essays represent an adequate history of the Bundesbank.
Hans-Joachim Voth is currently a visiting professor at the MIT economics department, and an associate professor at Universitat Pompeu Fabra, Barcelona. He is the author of Time and Work in England, 1750-1830 (Oxford: Oxford University Press, 2001), and a co-author of European Capital Markets (Houndsmills: Palgrave, 2000). His latest articles are “With a Bang, Not a Whimper: Pricking Germany’s Stockmarket Bubble in 1927 and the Slide into Depression” (Journal of Economic History, forthcoming) and (with S. Horrell, J. Humphries), “Destined for Deprivation? Human Capital Formation and Intergenerational Poverty in Nineteenth Century England” (Explorations in Economic History 38, 2001).
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