The European Council on Foreign Relations

€ view: Bundesbank - tactical gains but a strategic defeat

Date: 10th November 2011  |  Author: Sebastian Dullien,

Categories: € View, Euro Crisis, Germany in Europe, Reinventing Europe,
Tags: , ecb, germany , germany, italy, greece, bundesbank

The past week looked like another brilliant victory for the German Bundesbank, defending its staunch principles of orthodox monetary policy against the challenges from the rest of the world. Already at the euro summit at the end of October, the Bundesbank had gotten its way when the German chancellor Angela Merkel stroke down the French idea to give the EFSF a bank license to borrow money from the ECB so that it could increase its firepower and buy more government debt from euro-countries under pressure, such as Spain or Italy. Now, quoting its legal task of safe-guarding the German foreign exchange reserves (a task in many other countries regularly performed by the Finance Ministry), the Bundesbank managed to shoot down the idea discussed at the G20 meeting in Cannes that European countries could use their special drawing rights at the IMF to leverage the EFSF.

Of course, judging from a democratic legitimacy perspective, the Bundesbank may have a point. If national governments cannot convince their national parliaments to increase the volume of the EFSF directly and hence take up more risks for national budgets, it seems not completely honest to use the special drawing rights. In the end, putting SDR into the EFSF would increase the contributing countries’ exposures, just as increasing the European countries’ guarantees for the EFSF. For the governments it seems the easier way as usually, parliaments do not have to vote on the use of SDRs and the public might not understand the technicalities involved here.

Yet, it is fair to assume that the Bundesbank is not that much concerned with legitimacy and transparency. In Germany, there is a long history of not publicly criticizing the Bundesbank, with occasional stories of the Bundesbank censoring critical journalists by cutting them off vital information (at least as reported privately by journalists).

Instead, the Bundesbank seems to be much more concerned with the monetary policy consequences of using special drawing rights for leveraging the EFSF capital. In its eyes, the discussed EFSF-SDR construction de facto means an indirect financing of government debt through the ECB. This is seen as another step away from orthodox monetary policy making and the separation of monetary and fiscal policy the Germans are so keen on.

However, the tactical victories of the Bundesbank of the past weeks might turn out to have moved it further towards a strategic defeat in the end. The Bundesbank has now shot down two ways which would have been possible for effectively leveraging the EFSF and hence giving it at least a chance of successfully battling the sovereign debt crisis in Europe. With one option after another disappearing, the euro area is moving closer to the point at which only one policy will be able to keep the currency union from breaking apart: the large-scale direct purchase of government bonds by the ECB and a guarantee from the central bank that yields on government bonds will not be allowed to increase above a certain threshold.

When the euro area arrives at this point, both further perceivable developments look unfavorable for the Bundesbank: If the majority at the ECB council then decides to do what is necessary and vote down the German opposition in the council, the Bundesbank has clearly and openly lost its months-long fight against the ECB’s bond purchases.

If, on the other hand, the ECB does not decide in time on large purchases of government bonds and the euro area actually breaks apart with an exit of countries such as Italy and possibly France, the legacy of the Bundesbank will be seriously damaged. A break-up of the euro-area has the potential to become the economically worst turmoil for Europe since the Great Depression with unpredictable political consequences. While in the short run this might leave the Bundesbank with its own currency and the power to set its own interest rate again, the backlash against the institution might be enormous. Historians then will judge the Bundesbank’s performance in the current crisis at par with the Federal Reserve’s performance in the late 1920s (which is nowadays almost anonymously seen to be one of the reasons for the Great Depression). Under such a scenario, even the Germans might at some point turn against their beloved Bundesbank. And the Bundesbank might not be quite as immune to public pressure as the ECB: while the ECB’s independence is protected by the EU Treaty and can only be altered by unanimous treaty change, the Bundesbank’s independence is only guarded by a simple German law which can be changed at any moment with a simple majority in the German Bundestag.

Share or like this blog post Print this post