Mario
Draghi, the ECB and German trauma
How
Germany has fundamentally misconstrued European monetary policy.
By MICHAEL HÜTHER
4/20/16, 5:36 AM CET
COLOGNE, Germany —
Inflation is the trauma of the Germans. Twice in the 20th century,
financial assets were devalued and hyperinflation ruined the economic
life. The founding myth of the Federal Republic of Germany was
therefore not the creation in 1949 of the constitution, or Basic Law,
but the currency reform a year earlier. Before that reform, the
public mood had hit rock bottom while suicide rates peaked. From
1948, economic development resumed, price stability returned, and
social life and the political system got back to normal.
This historical
dimension continued to cast its shadow over the early stages of
European monetary integration in the late 1980s. The Maastricht
Treaty that outlined the independence of the European Central Bank
and its mandate primarily to ensure price stability was born out of
the German experience and the model of the Bundesbank. Only these
guarantees made letting go of the Deutsche-Mark politically feasible.
Many Germans
fundamentally misconceive European monetary policy. They believe the
ECB to be a new Bundesbank, which delivers reliable monetary policy
tailored to German needs. The fact that monetary policy in a monetary
union with structurally different economies cannot satisfy everyone
has been ignored or suppressed by many Germans. This misunderstanding
was not an issue as long as the ECB was able to reliably secure a
stable price level without unconventional measures.
[Many
Germans] believe the ECB to be a new Bundesbank, which delivers
reliable monetary policy tailored to German needs.
The Bundesbank has
never experienced the need for unconventional monetary policy
measures. Compared to the Fed, the German central bank was a haven of
conservatism in monetary policy. Even the admission of Money Market
Funds in Germany in 1994 was accompanied by criticism because of
possible incentives for short-term actions. Unlike the ECB, the
Bundesbank was never required to support economic policy by pursuing
a high level of employment and sustainable growth without endangering
price stability.
This explains why
many Germans condemn the ECB’s unconventional monetary policy. This
criticism has quite good reasons, but it goes far beyond the factual
framework. The reputational risk for the European Central Bank is
widely considered irrelevant. And yet this risk increases the longer
the ECB keeps on missing its self-defined goal of price stability.
In 2003, the ECB
reviewed its strategy and target: The pursuit of price stability
should aim to maintain inflation rates close to 2 percent over the
medium term. The idea was to underline the ECB’s commitment to
providing a sufficient safety margin to guard against the risks of
deflation, with the 2 percent target rate allowing for different
rates of inflation within the euro area.
The
ECB is criticized for expropriating savers with its low interest rate
policy. In fact, negative real interest rates are not new.
German politics, the
public and the media tend to dismiss as a mere macroeconomic issue
the risk of nominal short-term interest rates at or near zero causing
a liquidity trap and limiting the central bank’s capacity to
stimulate economic growth. The historical trauma of inflation
obscures this problem.
In addition, the ECB
is criticized for expropriating savers with its low interest rate
policy. In fact, negative real interest rates are not new: They
occurred after the oil crisis in the mid-1970s and after German
reunification in the early ’90s.
The German polemic
against the ECB obscures more legitimate concerns. ECB monetary
policy has started to resemble the Bank of Japan’s. As a result of
ruptured credit bubbles and subsequent banking crises, both central
banks are facing stagnating economic growth and price development
close to deflation. Large purchasing programs of government bonds,
zero interest rates and now even negative nominal interest rates have
not brought about normalization so far.
In Japan, the result
is a structurally weak economy, in which the transmission of monetary
policy to the real economy — in a country where bank lending is the
dominant route — has stalled despite massive intervention. The lack
of reforms is a serious issue.
The
German polemic against the ECB obscures more legitimate concerns.
Europe’s financial
system is also bank-based and as such a functioning banking system is
similarly essential to the effectiveness of the Continent’s
monetary policy. The right response to the banking crisis would have
been re-capitalization of the banks and balance sheet adjustments.
In recent years,
nearly 80 percent of the systemically important banks of the euro
area have had to shrink their lending. This has led to a
disintegration of the ECB bank lending channel into 18 national
channels — and these channels only work in a few countries, such as
Germany. However, for countries with a sound banking system, ECB
monetary policy is now too expansionary. It will diminish banks’
interest income and have negative effects on bank lending.
Persistent low
interest rates are also the result of a strategic game between the
ECB and the governments of the debtor countries. If these countries
were to enhance their reform efforts, then the ECB could (and would)
raise interest rates. In the case of successful reforms, the low
interest rate policy would indeed be inflationary. But higher
interest rates would complicate government financing, and lower the
incentive for reform. The result now is an overall economically
inefficient situation of reform deadlock and low interest rates.
Countries should not
be passing the buck to the ECB — responsibility rests with the
governments.
While interest costs
for France, Italy and Spain have fallen since the beginning of the
ECB’s quantitative easing program, their total government deficits
and especially their structural budget deficits have increased.
Reforms in the banking sector have so far largely failed to
materialize. Non-performing loans in the euro area have increased
steadily since the crisis began. They still amount to more than €800
billion. Italy’s announcement to set up a “bad bank” is
certainly a necessary step forward, but it is far too late.
The governments of
euro countries overburden monetary policy with their failure to
reform. All this harms the ECB’s reputation and destabilizes the
euro. Postponed reforms threaten to forge economic structures in the
euro area as stale as Japan’s, while leading to even greater
disintegration. EU countries should not be passing the buck to the
ECB — responsibility rests with the governments. The ECB,
meanwhile, should phase out unconventional policy in a slow,
controlled way that includes proper communication to avoid a capital
market shock.
Michael Hüther is
director of the Cologne Institute for Economic Research.
Authors:
Michael Hüther
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