Europe's Monetary Policy: The End of an Era

The previous history of the European Central Bank (ECB) can be roughly divided into two epochs.

In the first epoch, from its founding in 1998 to 2011, the ECB was visibly in the tradition of the Deutsche Bundesbank.

This tradition was embodied by their German chief economists Otmar Issing and Jürgen Stark.

This era ended with the outbreak of the euro crisis and the resignation of Stark and the then President of the Deutsche Bundesbank, Axel Weber.

The appointment of Jens Weidmann as Weber's successor at least ensured that the tradition of the Bundesbank in the management of the ECB still had an audible voice after 2011.

The majority in the Central Bank Council, however, diverged more and more from the Bundesbank tradition.

Driven by the interests of other member states of the monetary union, it approached an American understanding of monetary policy.

How Much Inflation is OK?

The main difference between the traditional German and the American understanding of monetary policy concerns the interpretation of the independence of the central bank and the question of the extent to which inflation has to be temporarily accepted in the interests of economic growth. The traditional German understanding tries above all to separate monetary policy and financial policy sharply and not to allow monetary policy to be absorbed by financial policy. This idea has been adopted in the law on monetary union in the form of the ban on monetary state financing.

The American conception of monetary policy considers the attempt to strictly separate monetary and financial policy to be artificial; In the monetary union, this notion was mainly taken up in countries that are interested in the central bank buying their bonds. Attempts from Germany to have the Bundesbank's participation in the ECB's bond purchases prohibited by the Federal Constitutional Court, at least so far, have not been a resounding success.

Weidmann considered bond purchases to be justifiable as a monetary policy instrument in times of need.

He was on the side of the majority of economists.

But with his warnings of a creeping loss of the independence of monetary policy vis-à-vis governments and financial markets in the event of an expansion of bond purchases beyond times of emergency, he found himself in a minority on the ECB's Central Bank Council.

Who will be the successor?

The concern that a central bank that does not find out about buying government bonds in good time will become increasingly dependent on governments and financial markets has not yet been embraced by a majority of the Central Bank Council. The ECB has at least expanded its mandate, supported by governments, which were and are very happy with the very active monetary policy of the ECB. This also applies to the federal government that is still in office.

Weidmann's withdrawal does not change the balance of power in the Central Bank Council of the ECB. That is why the international financial markets hardly reacted to the news. Nevertheless, the withdrawal means the end of an era, because the federal government led by the SPD will undoubtedly take the opportunity to look for a successor who is less likely than Weidmann to raise concerns about the close intertwining of monetary and financial policy.

At a time when the European fiscal rules are once again being reviewed and the search for a creative circumvention of the debt brake in the SPD and the Greens is in full swing, a central bank that is always ready to buy bonds is fulfilling the hopes of those with an expansive Want to pursue financial policy. With Weidmann's farewell, the tradition of the Bundesbank in European monetary policy is visibly coming to an end.

That this is happening at a time of rising inflation is anything but good news. Proponents of the monetary policy that has been practiced for ten years always had the argument at hand that, contrary to fears, especially in Germany, high inflation rates did not play a role. But now there is a risk that the European Central Bank will underestimate the dangers of inflation. Anyone who compares the current rhetoric of leading ECB representatives with the rhetoric of other central banks gets the impression that the ECB is well behind the curve.

At the same time, the European Central Bank is looking for ways to buy government bonds on a large scale after the pandemic.

You don't need a crystal ball to foresee further disputes about the role of the Bundesbank in these proceedings before the Federal Constitutional Court.

Jens Weidmann's withdrawal may officially have personal reasons, which of course have to be respected.

In fact, the withdrawal is an alarm signal for all supporters of a stability-oriented monetary policy.