The Cecchetti–Schoenholtz brief was published in November 2008 just around the tenth anniversary time for EMU and so it is no surprise that some of those interviewed were in reflective mood. Anniversaries
are a time for looking back and forward. Bundesbank President Weber expressed the view (to the authors) that:
I think the success is the high degree to which price stability has been achieved […]. Long-term inflation expectations have been stable and low and anchored at the level defined as price stability.
Hans Tietmeyer, founder ECB policy-board member in 1998 and Bundesbank President (1993–9) states (to the authors of the brief) that
From the beginning, the ECB was seen inside and outside the euro- area as independent and credible.
The then (in early 2008) New York Federal Reserve President Timothy Geithner (subsequently Treasury Secretary under President Obama) told the authors:
Since the ECB has been setting monetary policy, it has not produced a sustained period of sub-par growth; the euro-area has not experi- enced greater volatility of economic growth; and there has certainly not been any erosion of inflation performance. All this suggests that the ECB is performing well.
A problem with the claim of stability
Um! The Bank of France and Bundesbank had both achieved inflation of 1% p.a. or less before the start of EMU. What did the creation of EMU and the ECB offer French and German citizens that they did not have already in terms of stability?
In fact as highlighted in earlier chapters the ECB was most probably more vulnerable than would have been a still sovereign Bundesbank to the monetary preachers warning that ‘inflation might fall too low’.
‘Vulnerable’ here includes lack of resistance to a false IMF-alarm on German and indeed global deflation risks. And it is hard to believe that the German government would have been ever been an ally of the IMF in swaying the ‘Old’ Bundesbank (defined to exclude the 1990s, see below) against its better judgement. (By contrast in spring 2003, Berlin, Frankfurt – including the ‘new Bundesbank’ and Washington – had all been in step about the phoney danger of deflation.)
And at no point was the Bundesbank an inflation-targeter or quasi- inflation targeter, as the ECB became, with its consequences of deep monetary disequilibrium. As for the record, the Bundesbank over more
than a decade (1975–87) pursued a target for the monetary base (central bank money stock), putting much less emphasis than the ECB on rigid pegging of the overnight money market rates (see Leaman, 2001) or on signalling to markets the likely future path of any pegging operations (thereby influencing market rates for longer maturities). That was con- sistent with a set of principles emphasizing monetary stability of which a stable price level over the very long run would be the accompaniment but with no hang-up about delivering stability of a consumer price index over a two-year period. The erosion of principles at the Bundesbank came largely in the run-up to EMU (and even previously during the con- summation of German Monetary Union) when the leadership of that institution became increasingly subject to the overriding European (and German union) objectives of Chancellor Kohl, buttressed by his choice of a monetary chief likely to be compliant with those.
Counter-factual peril – The old Bundesbank would have done better!
It is always dangerous to undertake counter-factual history-making. Even so, it is hard to imagine that without monetary union the member coun- tries either singly or together would have gone down the road of breathing inflation higher. If the monetary order had remained unchanged – with the Bundesbank enjoying hegemony – there might have been some one- off exchange realignments in the late 1990s so that the mark would have fallen in value vis-à-vis some of its main partners. The German price level would not have been under any downward pressure in that event.
In any case there is no reason to believe that a staunchly independent and self-confident Bundesbank, not weakened by a train journey to GMU (German Monetary Union) and then EMU, would have been inclined to follow currently popular monetary practice as set by the Bernanke/
Greenspan Federal Reserve and praised by the IMF.
The ECB, however, as a new institution, had no such self-assurance or indeed inclination to defy fashion as set by the Federal Reserve. There was no ‘old guard’ within the new central bank, steeped in alterna- tive monetary doctrine, and ready to do battle with the latest version of monetary populism. The Schroeder Government was siding with Washington on deflation risk (and the need to counter it). ECB officials were enjoying their time in the sun as issuers of the new global money and as partakers in the brainstorming of the annual Federal Reserve research symposium (at Kansas) or like events where the ten Bernanke principles of inflation-targeting (a follow on from the Blinder doctrine
whereby the central bank should ignore temperature upswings in asset and credit markets, concentrating instead on goods and services price changes) made up the popular gospel (amid some dissent, most notably from the BIS chief economist, William White). The old Bundesbankers, by contrast, may have decided to just stay at home! (See Brown, 2008, for a statement of the ten Bernanke principles.)
The Bundesbank at this time (2003) was at a low ebb in terms of lead- ership, direction and exercise of influence. The current president, Ernst Welteke (the successor in 1999 to Hans Tietmeyer, the Bundesbank president who had never raised interest rates and had remained loyal to Chancellor Kohl throughout the five years running up to the launch of EMU, see Marsh, 2009) had been a blatantly political appointment of Chancellor Schroeder. Welteke’s rise to the top had run from head of the SPD faction in the Hesse Federal parliament, to regional board member of the Bundesbank (appointed there by Hesse Prime Minister Eichel), to head of the Bundesbank (appointed there by Chancellor Schroeder on the advice of his finance minister, Hans Eichel).
In a counter-factual world in 2003 with a sovereign DM and a ‘non- corrupted’ Bundesbank still calling the monetary shots for Europe, it is hard to believe that any of the other central banks on their own would have followed the lead of the IMF or Bernanke/Greenspan Fed in deciding to breathe inflation back into their individual economies.
If deflation were to in fact materialize in any of these countries outside Germany, a quick effective answer could be a downward adjustment of their currency against the Deutsche mark. There would be no need to take pre-emptive action now to bolster the inflation rate!
So what did Messrs Weber and Tietmeyer actually believe that the ECB had brought to the party? (see p. 144). The authors of the brief do not tell us! As regards Tim Geithner’s comment, presumably he would not have made it six months later into the European Slump of winter 2008–9!
It is also dubious whether Professor John Taylor would have made his flattering comment quoted in the brief if interviewed a few months later:
The biggest success of EMU to date has been to set it up from scratch, to deal with the inherent difficulties of communication and different traditions, and to have a policy apparatus which is basically working well in terms of interest rate decisions. That has to be viewed as a major achievement. It’s the first time anything like that has been done.
Surely Professor Taylor as assistant secretary of the Treasury in charge of international affairs under the first Bush Administration (2001–5) was
aware of the ECB’s decision in spring 2003 to follow its own version of breathing inflation back into the economy (just as the Bernanke/
Greenspan Federal Reserve was doing at the time)? And indeed in his critique published in 2009 of the Federal Reserve’s role in the bubble- and-burst he makes explicit reference to the monetary errors in the euro-area at the same time. (These are cast, however, simplistically in terms of whether interest rates were above or below the level specified by the ‘Taylor rule’ as calculated for the individual member countries, most notably those ‘enjoying’ warm temperatures in their credit and real estate markets, rather than in terms of faulty monetary principles.)
It is far less clear whether Paul Volcker (not interviewed by the authors of the brief) was so familiar with euro-history when he praised EMU in late 2008 (Volcker, 2008). He told the assembled dignitaries at a conference held in honour of Helmut Schmidt (the German chancellor under which the train to EMU started with the launch in 1978 of the European Monetary System) that
Today, on the 30th anniversary of the EMS, the world economy faces a new and severe challenge reflected in the volatility of the US dollar and extraordinary pressure on the international financial system. In the midst of the great uncertainties, there is no doubt in my mind that Europe and therefore the world is better able to cope with that crisis by virtue of having achieved a common European currency.
Perhaps this was the type of glib praise which Paul Volcker might have re-considered later if in full possession of present and subsequent facts just as Milton Friedman might have revised subsequently his praise in 2006 (at age 94!) of Alan Greenspan (congratulating him as the Federal Reserve president whose record had refuted his long-run view of that institution as a perennial source of monetary instability).