New Bundesbank President: The Challenge of Joachim Nagel

The celebration of the change in the office of President of the Deutsche Bundesbank took place at a very exciting time from a monetary policy point of view.

Because at the same time as Jens Weidmann was handed over to Joachim Nagel in the Bundesbank, the conflict over the correct assessment of the current inflation risk broke out in the headquarters of the European Central Bank (ECB), which is only a few kilometers away as the crow flies.

Last weekend, board member Isabel Schnabel emphasized that the forced use of green energy would bring with it the risk of a higher inflation rate. Monetary policy cannot afford to ignore higher energy prices if they pose a risk to medium-term price stability, said Schnabel. This would mean that monetary policy could be tightened earlier than previously expected.

However, this assessment contradicts the official line of the ECB, which was largely shaped by the board member responsible for economics, Philip Lane, which from today's perspective expects a reduction but no cessation of bond purchases for 2022 and excludes a key rate hike.

In a recent interview with the Italian daily “Il Sole 24 Ore”, Lane reiterated his position: “We are not seeing any behavior that suggests that inflation will remain above our target in the medium term.

We knew that by the end of 2021 we would have a concentration of price pressures, largely due to the sharp rise in energy prices.

But the narrative remains unchanged. "

Underestimated the surge in inflation

Lane is a very powerful man in the ECB - and quite a respected economist in the professional world. It embodies the long-standing thinking that medium-term inflation depends heavily on expectations of future inflation rates in financial markets and in companies, as well as on the development of the labor market. Rising prices for energy or price increases due to disrupted supply chains are mostly interpreted as temporary. For Lane, the current inflation rate is less important than measurements according to which inflation rates on the financial markets are expected to be slightly below the ECB's target of two percent in 2023 and 2024.

This way of thinking about monetary policy may be justifiable in quiet times. It is implicitly based on the assumption that the world will revert to old macroeconomic patterns once the pandemic has been overcome. But that is highly unsafe. The contribution of active climate policy to currency devaluation discussed by Schnabel could bring about a shift in monetary policy coordinates as well as the foreseeable shortage of qualified workers due to the baby boomers entering retirement and the considerations of many companies to trust globalization less and then to return productions to their home regions relocate when they get more expensive there.

The idea of ​​using inflation expectations several years in the future as a guide for monetary policy also stems from textbooks written in other times.

Like many other institutions, the ECB had completely underestimated the current surge in inflation.

As the new President of the Bundesbank, Joachim Nagel will have a say in future monetary policy in the Central Bank Council of the ECB.

Contrary to a widespread misunderstanding, Nagel is not joining the Council as the official representative of Germany, but as a formally independent expert on monetary policy, and like his predecessors, he therefore wants to form his own monetary policy judgment.

But of course, as a long-time employee of the Bundesbank, Nagel carries the Bundesbank's convictions.

That includes being aware of the concerns that many people have about inflation.

By stating that inflation could remain at a higher level for longer than previously expected and that the ECB must therefore be on its guard, Nagel certainly did not take up positions by chance that put him in a tradition with his predecessor Jens Weidmann.

His advocacy of a narrow interpretation of the ECB's mandate and his demand on financial policy that high debt ratios should be reduced have long been known from the Bundesbank.

With the return of inflation, there is a prospect that Nagel will be able to exert a more lasting influence on European monetary policy than his predecessor Weidmann was granted.