«The Monetary Policy Decision Process in the Federal Republic of Germany Manfred Willms* Introduction In theoretical analysis and econometric models ...»
The Monetary Policy Decision Process in the
Federal Republic of Germany
In theoretical analysis and econometric models monetary policy is generally treated as being exogenously determined. It is assumed that the central bank operates in the public interest, i.e., that it tries to realize the main
goals of economic policy simultaneously: stabilization of the price level,
full employment, high growth rates of real GNP and balance of payments
In more recent approaches both the exogeneity of monetary policy decisions and the public interest hypothesis have been questioned. Central" banks and their behavior are incorporated into the general economic and political process. This implies that central banks do not react independently with respect to a given economic situation. Deviations between actual and desired goal variables of monetary policy as well as political pressure influence the decisions of the central bank. The question then is, to which disturbances do central banks react and how strong is their reaction pattern. In the following analysis an answer to this question shall be given for the behavior of the Deutsche Bundesbank. In addition, whether the Bundesbank has followed a discretionary or a nondiscretionary monetary policy over the past 22 years will be empirically analyzed.
Iio Principles of Monetary Policy: Discretionary versus Noudiscretionary Policy Monetary policy can be conducted either as discretionary or as nondiscretionary policy.
Arguments in favor of a discretionary policy are:
(1) The economy is a constant deterministic or stochastic system, where the impact of monetary policy actions on the final goal variables is systematically determined.
(2) Policymakers have a thorough understanding of the structural properties of the economy while private agents are poorly informed about the working of the economy and are unable to learn. Thus, policymakers can exploit the lower information level of the general public.
(3) Information on target variables of monetary policy is available with *Director, Institute of Economic Policy, University of Kiel
GERMAN MONETARY POLICY 35
WILLMSdifferent lags, Fine tuning is necessary to correct deviations between the course of "fast-speed" and "low-speed" target variables.
(4) Undesired results that are produced by monetary policy actions within the stochastic system can be corrected by prompt policy actions.
(5) The central bank is an institution that operates in the public interest and tries to make its operations as transparent as possible.
The proponents of a discretionary policy assert that it achieves a higher performance level of the economy thanany other policy. The flexible adjustment to all possible disturbances is considered to be a great advantage of this type of monetary policy. The basic assumption behind this approach is that the private sector of the economy is inherently subject to shocks which are caused by erratic changes of aggregate demand, mainly due to shifts in the marginal efficiency of capital (Keynesian view of the economy).
Nondiscretionary policy can be executed by following some precommitted constraints or by following a fixed rule of monetary expansion.
Arguments in favor of a nondiscretionary policy are:
(1) The structure of the economy is not fixed. It changes with variations of the policy regime. Economic agents modify their behavior by absorbing information on the effect of policy actions.
(2) Policymakers do not have a monopoly of information on the structural proPerties of the economy. Private agents are--on the average--able to learn to understand how the economy works and how it is affected by policy actions. The accumulation of all available information on economic affairs by private agents leads to the rejection of the hypothesis of systematic long-lasting effects of monetary policy on the real sector of the economy.
(3) A central bank should only have one target variable of monetary policy and not "look at everything."
(4) A nondiscretionary monetary policy reduces the uncertainty about the current and future course of the development of monetary policy variables and thus improves the framework for the private decisionmaking process.
(5) Central banks do not act independently of the political process and follow their own preference function. In order to prevent a critical evaluation of their decisions they prefer to issue vague statements concerning their actions and an unconstrained activism.
(6) Central banks are not interested in a nondiscretionary policy since their degree of public esteem and thus their welfare level increase with the development of new instruments and their more frequent use.
The proponents of a nondiscretionary policy are convinced that this policy stabilizes the economy’s long-term real growth rate and the rate of 1Some of these arguments are derived from Karl Brunner, "The Pragmatic and Intellectual Tradition of Monetary Policymaking and the International Monetary Order," unpublished paper presented at Geldtheoretischer Ausschul3 des Vereins fiJr Socialpolitik, Frankfurt, July 1982.
36 MONETARY POLICY inflation more than a discretionary policy. A nondiscretionary policy allows for higher real growth through reducing information costs on investment and thus leads to more capital formation and a better utilization of the existing capital stock. Discretionary monetary policy itself--according to this approach--causes the destabilization of aggregate demand and the cyclical fluctuations of the economy. The private sector is assumed to be basically stable since the demand for money is a stable function of some predetermined variables. Most of the fluctuations of aggregate demand for goods and services are the result of fluctuations of the money supply caused by the central bank (monetarist view of the economy).
Ill. The Legal Framework of Monetary Policy in Germany
1. The Main Goal of Monetary Policy as defined by the Bundesbank Law of 1957 The main goal of monetary policy of the Deutsche Bundesbank is to ensure the stability of the price level. This goal is explicitly mentioned in paragraph 3 of the Law of the Deutsche Bundesbank (Gesetz tiber die Deutsche Bundesbank von 1957).2 According to paragraph 3 the Bundesbank has to expand the supply of money and credit with special regard to the stabilization of the price level.
Thus the Bundesbank Law is based on the classical view of economic theory that the main task of monetary policy is to prevent inflation. The focusing on the goal of price stability has its origin in the experience the Germans had with inflation during the twenties. Since then the Germans have become more sensitive towards inflation than people in many other countries.
However, the Bundesbank Law also requires the Bank to support the general economic policy of the government) On first glance this could imply that the Bundesbank can be forced by the government to finance an official inflationary full-employment policy. The law itself protects the Bundesbank against such pressure by two qualifications: 1. The support of government policy ends when the goal of price stability is in danger; 2. The Bundesbank makes its decisions independently of the government.
2. The Independence of the Bundesbank The Bundesbank is a public institution, whose capital is owned by the Federal Government and which provides itself with its own funds. Responsibility for monetary policy decisions rests with the Central Bank Council (Zentralbankrat). This Council consists of 17 members, namely the 6 members of the Directorate of the Bundesbank and the 11 presidents of the (regional) State Central Banks (Landeszentralbanken). The Directorate 2Gesetz fiber die Deutsche Bundesbank, Frankfurt 1957, paragraph 3.
3Ibid., paragraph 2.
GERMAN MONETARY POLICY WILLMS 37has to execute the decisions of the Central Bank Council. Both the council and the Directorate operate basically independently of the government and other economic and political institutions. However, paragraph 13 of the Bundesbank Law requires the Bundesbank to consult the Federal Government in decisions that have substantial effects on monetary variables. Members of the Federal Government have the right to attend the meetings of the Central Bank Council. Although they are not allowed to vote they can include points on the agenda and can delay decisions by two weeks. Conversely, the Federal Government has to consult the President of the Bundesbank in decisions that affect national and international monetary matters.
The last point is of special importance since the Federal Government and not the Bundesbank is officially responsible for all international financial agreements such as those involving the International Monetary Fund or the European Monetary System.
Members of the government have frequently attended meetings of the Central Bank Council while the President of the Bundesbank has only occasionally participated in meetings of the government. From time to time the government has decided on policy matters affecting monetary variables without consulting the Bundesbank.4 While the political influence of the government on the operational level of the Bundesbank is rather small its influence through the appointment of the members of the Council and the Directorate is much more significant. The president, the vice-president and the other members of the Directorate are put in power by the Federal Government. Their term is generally eight years but can also be as short as two years. The presidents of the 11 State Central Banks are de facto selected by the State Governments.
Their term is also generally eight years.
In the 1950s and 1960s the Federal Government and the State Governments generally appointed qualified central bank experts suggested by the Bundesbank. In the 1970s the Socialdemocratic governments in Bonn as well as in the states broke with this tradition and frequently appointed party members or members of the trade unions without central bank experience.
In several cases the appointments have been pushed through against the objection of the Central Bank Council.5 The impact of the political appointments on the policy of the Bundesbank is difficult to ascertain.
3. Instruments and Intermediate Target Variables of Monetary Policy In order to carry out its tasks as specified by the law the Bundesbank has a variety of instruments available in the form of the discount policy, Lombard policy, open market policy and the minimum reserve policy.
4Rolf Caesar, Der Hanlungsspielraum yon Notenbanken, Nomos, Baden-Baden 1981, p.
SIbid. p. 187 38 MONETARY POLICY Through the discount policy commercial banks can obtain credit generally for three months from the Bundesbank against commercial drafts. The Bundesbank determines the discount rate and the rediscount quota. The quota is set individually for each bank. An overextension of the quota is not allowed. Only qualified drafts are accepted by the Bundesbank.
Lombard policy is the allowance of credit from the Bundesbank against collateral. Such credits are only granted for very short periods of time (normally not more than seven days); their purpose is to help commercial banks overcome short-run liquidity squeezes. The Bundesbank has the right to abandon the supply of Lombard credits completely. Instead of the ordinary Lombard credit it can introduce a special Lombard credit at a special Lombard rate. This special Lombard credit can be cancelled daily and the rate can be changed daily.
Open market policy consists of the purchase and sale of different types of bonds or papers in the open market. The Bundesbank usually sets the rate at which it buys or sells thes~ papers to commercial banks while commercial banks decide about the quantity they want to hold in their portfolio.
However, from time to time the Bundesbank has fixed the quantity of papers it intends to buy or to sell, leaving the determination of the interest rate to market forces. In addition, the Bundesbank can buy open market papers or commercial drafts from commercial banks under special repurchase agreements (Offenmarktgesch~ifte fiber Wertpapiere mit Rtickkaufsvereinbarung). In the recent past this instrument of monetary policy has become more and more important.
Minimum reserves ar.e imposed on the deposits of all credit institutions including branches of forgign banks. Only a few institutions like the postal office, the social security system, insurance companies and the Bundesbank itself are exempted. Reserves must be held on deposits of nonbanks and foreign banks with a maturity of less than four years. Minimum reserve rates are differentiated with respect to maturity. For demand deposits the maximum rate is 30 percent, for time deposits it is 20 percent and for savings deposits it is 10 percent. For nonresident deposits the Bundesbank can impose a reserve ratio up to 100 percent. If the minimum reserves are below their required level, commercial banks have to pay a penalty.
Almost all the Bundesbank’s tools are nondirigistic in nature. Tools like credit-rationing, fixing interest rates on credits and deposits or direct capital controls are not available to the Bundesbank. In Germany monetary policy operates by influencing the conditions in the market for shortterm assets. The Bundesbank controls bank liquidity, money, and credit mainly by changing the relative prices of assets.
The collection of monetary policy instruments as set forth in the Bundesbank Law of 1957 has so far proved to be very adequate; as such, the introduction of basically new instruments has not been necessary. With their given tools the Bundesbank was able to handle even difficult situations in the sixties and seventies.