The end of the Bundesbank era

Published in Newsroom.co.nz (Wellington), 2 November 2021

It will not just be the last General Council meeting of the European Central Bank for the year when it meets on December 2. It will also be the end of an era.

Jens Weidmann, the President of Germany’s Bundesbank, has announced he will step down at the end of the year “for personal reasons.”

With Weidmann’s imminent departure, the ECB will lose its most hawkish governor. The move will also symbolise the ECB’s transition into a less stability-oriented institution – right when high inflation expectations in Europe are taking hold.

Despite Weidmann’s “personal reasons,” his resignation letter to the Bundesbank’s staff revealed how isolated he may have felt within the ECB. “Remain an audible voice of reason in public discussions and preserve the Bundesbank’s important stability policy legacy, which makes this institution so unique,” he wrote.

The focus of the Bundesbank on price stability is indeed quite unique because the ECB’s President Christine Lagarde and most of its Council do not share it. Apart from its Dutch and Austrian members, the rest of the ECB’s Council is quite comfortable with more activist monetary policy.

The ECB’s new dovish stance is the opposite of its historical purpose. To appreciate just how much has changed, it is worth considering its origins.

After decades of talking vaguely about European monetary union, that vision became reality with the Maastricht Treaty of 1992.

The fall of the Berlin Wall in 1989 and the unification of Germany in 1990 occurred around the same time, and that was no coincidence. For all we know, to obtain international approval for the merger of the two states, Germany sacrificed its beloved Deutsche Mark.

A large majority of the Germans were not at all happy with European monetary union. In response to two hyperinflations during the early 20th century, the country had established a hard currency under the auspices of the Bundesbank. Its sole task was to protect the stability of the Deutsche Mark. And it did.

The Bundesbank’s stability success established its reputation. Jacques Delors, then President of the European Commission, summed it up perfectly: “Not all Germans believe in God, but all believe in the Bundesbank.”

When the time came to create the European Central Bank, the Bundesbank served as a model. It did so to appease the Germans, who were reluctant to give up both their currency and their central bank. The creation of the new Bundesbank-style central bank was also a promise to southern Europeans that their new currency would be as strong as the Deutsche Mark and not a Spanish Peseta, Italian Lira or even French Franc under another name.

Thus, the ECB received the same sole mandate on price stability as the Bundesbank. To remove the Bank as much as possible from day-to-day politics, its President was to serve an eight-year term, non-renewable. To further emphasize the symbolism, the ECB’s headquarters are in Frankfurt – a short stroll from the Bundesbank.

It is rare for a national institution to be cloned into an international one like the Bundesbank. But that makes the ECB’s repositioning even more remarkable.

It started even before day one. Dutchman Wim Duisenberg became the first President of the ECB. He got his job on the condition that he would step down halfway through his term to make room for Jean-Claude Trichet, director of the Banque de France.

The stability-oriented catalogue of the Maastricht Treaty proved to be worthless. The criteria did not prevent Italy or Greece from joining the Euro despite their high levels of public debt. In the early 2000s, both Germany and France violated deficit rules without consequence.

The Greek government’s admission that it had manipulated its public finance statistics triggered the Euro crisis in 2009. With government yields spiralling out of control, the ECB’s President Mario Draghi went beyond the Bank’s price stability mandate to promise to do “whatever it takes” to save the Euro.

Draghi’s actions probably prevented a collapse of the Eurozone. But they came at the expense of turning the ECB into a political player. Instead of focusing on price stability, the ECB now dedicated itself to stabilising European governments and banking systems. Then Bundesbank President Axel Weber and the ECB’s chief economist Jürgen Stark both resigned in protest.

Jens Weidmann, a former aide to Angela Merkel, succeeded Weber. Weidmann quickly proved anyone wrong who thought his background would make him more susceptible to political pressure.

For his entire decade as President of the Bundesbank (and in that function a member of the ECB’s Governing Council), Weidmann was a lone voice for the ECB’s original mandate and the Bundesbank’s DNA.

It was Weidmann who warned the ECB against engagement in political areas like climate change, for which it has no democratic mandate.

Weidmann was also a constant critic of ultra-low interest rates. In an interview in 2016, he said: “I’ve stressed time and again that the longer the ultra-accommodative monetary policy is left in place, the more ineffective it becomes. And it’s also worth noting that the more you put the pedal to the metal, the more serious the risks and side-effects you face.”

The Bundesbank President also kept reminding his ECB colleagues and the public that only economic reforms could increase Europe’s growth rate, not central bank activism. And, in one of his latest statements, he pointed out that the ‘P’ in the ECB’s emergency Covid package PEPP stood for ‘pandemic’, not ‘permanent’.

Weidmann’s repeated warnings against inflation have come true. Consumer price inflation is approaching five percent across the continent. German wholesale prices are up 13 percent from last year, the highest increase since the first oil crisis in 1974. German import prices increased by over 16 percent.

This would be the time for a stability-oriented central bank to fight the inflation monster before it takes on a life of its own. Instead, the ECB wants to believe the rise in prices is just a false alarm brought on by temporary factors.

Once Weidmann has left the building, the ECB will still be in Frankfurt. It will still have the same basis in EU Treaty Law. It will keep paying lip service to stability.

It will still exist, but it will no longer possess the spirit of its founding. It will be a central bank that would feel right at home in Paris, Rome, or Madrid. And Europe’s inflation rates will reflect this, too.

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