Wednesday, 28 October 2009

Monetary policy of Bundesbank 1975-1998

German banknotes

Around one year ago a paper was released, its name was

and it was written by:
Andreas Beyer (ECB)
Vitor Gaspar (Banco de Portugal, special adviser)
Christina Gerberding (Deutsche Bundesbank)
Otmar Issing (Centre for financial studies)

During the turbulent 1970s and 1980s the Bundesbank established an outstanding reputation in the world of central banking. Germany achieved a high degree of domestic stability and provided safe haven for investors in times of turmoil in the international financial system. Eventually the Bundesbank provided the role model for the European Central Bank. Hence, we examine an episode of lasting importance in European monetary history. The purpose of this paper is to highlight how the Bundesbank monetary policy strategy contributed to this success. We analyze the strategy as it was conceived, communicated and refined by the Bundesbank itself. We propose a theoretical framework where monetary targeting is interpreted, first and foremost, as a commitment device. In our setting, a monetary target helps anchoring inflation and inflation expectations. We derive an interest rate rule and show empirically that it approximates the way the Bundesbank conducted monetary policy over the period 1975-1998. We compare the Bundesbank's monetary policy rule with those of the FED and of the Bank of England. We find that the Bundesbank's policy reaction function was characterized by strong persistence of policy rates as well as a strong response to deviations of inflation from target and to the activity growth gap. In contrast, the response to the level of the output gap was not significant. In our empirical analysis we use real-time data, as available to policy-makers at the time.

Some excerpts:
"In the period 1960-1998, German inflation measured in accordance with the Consumer Price Index, was, on average 3.1 per cent per year [...] the lowest and most stable, as recorded internationally."

"The Mark, initially (1873) created as a currency based on gold had ended its existence in the hyperinflation of 1923 which destroyed Germany's civil society. The successor of the Mark, the Reichsmark, created in 1924 ended its short life with the currency reform of 1948. People had again lost most of their wealth invested in nominal assets.No wonder that a strong aversion against inflation and a desire for monetary stability became deeply entrenched in the mind of the German people!"

It would be interesting to know more about the dispute over currency union with East Germany. The paper doesn't talk about it; according to Wikipedia, the dispute between Helmut Kohl (then chancellor of West Germany) and Karl Otto Pöhl (president of Deutsche Bundesbank) led to the resignation of Pöhl. I assume it was a blow against the famous independence of Bundesbank "of instructions from the Federal Government".

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