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Lorenzo Bini Smaghi, "What the history of the Bundesbank might teach the ECB"

"This blog was originally published by the Financial Times"

To understand how the Bundesbank gained independence after the second world war, in particular with respect to the German government, reference is often made to October 1950. Informed that a majority of the central bank council was in favour of raising interest rates, Chancellor Konrad Adenauer forced the bank to meet in Bonn, the country’s capital, instead of Frankfurt. The chancellor asked the council not to tighten monetary policy, given the prevailing high level of unemployment. When Adenauer left the meeting, the council decided to raise interest rates by 200 basis points, rather than the 100 basis points originally planned.

Many people did not understand, and disagreed with the decision, but over time, they generally came round to the idea that it was the right move. Ever since, the memory of this moment has discouraged German politicians from trying to influence monetary policy.

The example set by the independence of the Bundesbank, achieved not only thanks to its statutes but also to its practice, was a key pillar in the creation of an independent European Central Bank. Yet, since the first days of the euro, European politicians of all countries – including Germany – have tried to influence the ECB. In the mid-2000s three European heads of government (Gerhard Schröder, Silvio Berlusconi and Jacques Chirac) publicly requested that the central bank not raise rates. The ECB refrained from adopting the same drastic method that the Bundesbank used 50 years earlier to assert its independence and rebuff pressure, and has so far avoided any kind of overreaction to political pressure.

Whenever it has been criticised, from one side or the other, it has answered by reminding us that its primary mandate is price stability, defined as an inflation rate below but close to 2 per cent over the medium term. And by noting that its track record has been better than any other European central bank prior to the euro.

This line of defense has partly worked, but it has not deterred politicians from continuing to try to influence the ECB, even when the latter sticks to its strictly defined mandate.

The political environment might be a bit more complicated today in the eurozone than it was in the 1950s (although this is arguable). But the ECB may at some point want to think about whether it needs to send a signal, as the Bundesbank did 65 years ago, to remind politicians of its independence and objective. One way it could do this would be by announcing on Thursday a program of quantitative easing far bigger in size than anyone is expecting, or to set as its only limit the achievement of the 2 per cent inflation objective.

Central banks have to be accountable, in particular to the public at large. But in the end accountability depends on meeting the stated objective, which is price stability. This may require being temporarily unpopular, for instance when they raise interest rates and possibly even when they cut rates or implement non-conventional policies. This is precisely the reason why central banks are independent, and not driven by the demands of short term politics.

 By: Lorenzo Bini Smaghi