Deutsche Bundesbank

The international fame of Germany's central bank, the Deutsche Bundesbank, rests on West Germany's low inflation record in the post-Second-World-War era, which, including the high-inflation 1970s, averaged 3 per cent over the 50-year history of the deutschmark from 1948 to 1998. "Buba", as the bank is called in the markets, has a reputation as an inflation hawk. Held in awe in some international political and financial circles, but scorned in others, the Bundesbank has established a firm backing in German public opinion and has generally enjoyed respect and support from across the political spectrum, too. Despite becoming part of the Eurosystem and surrendering its de facto monetary reign over Europe to the European Central Bank (ECB) with the euro change- over in 1999, the Bundesbank continues to wield disproportionate political power in policy debates both in Germany and at the European level today.

Viewing the (Deutsche) "Reichsbank" founded in 1876 as part of the to-be-dismantled centralized power machinery of Nazi Germany, the re-establishment of central banking in the three Western occupation zones of defeated Germany after the Second World War followed the decentralized model of the Federal Reserve System in the United States. In March 1948, the regional central banks (Landeszentralbanken; LZB) established since 1947 in the individual German Länder (states) were supplemented by a new Bank deutscherLänder (BdL) supposed to function as their federal headquarters. The BdL was located in Frankfurt and had representatives from the LZB on its Governing Council of policy makers as well as an Executive Board of managers. On British insistence, erect- ing the BdL as a proper bank rather than a mere (decision-making) board, the BdL was a preparatory measure for the planned Currency Reform of June 1948 (Häuser, 1998; Bernholz, 1999; Buchheim, 1999; Distel, 2003). The Allies' introduction of the deutsch- mark in conjunction with general price liberalization under the initiative of Ludwig Erhard, West Germany's later legendary minister of economic affairs, became seen as the foundation of the German "economic miracle" that ensued in the 1950s.

The establishment of the BdL and the birth of the deutschmark, which in due course became the subject of glorification by association with West Germany's re-emergence from the socio-economic and political cataclysm of the Second World War, thus pre- ceded the election of the first federal government of the Federal Republic of Germany in September 1949. By its statutes the BdL was also "independent" of political control by the German states. This guaranteed the Allied powers' full authority over the central bank still lacking a State, with control being exercised through the Allied Bank Commission (residing with the BdL under the same roof).

The end of Allied control then led to the Transition [central bank] Law of 1951, a hard-fought-over compromise between the BdL and the federal government of Konrad Adenauer. The compromise formula foresaw that the BdL was independent from gov- ernment instructions in safeguarding the currency but obliged to take into account and support the government's economic policy - a formula that made its way into the Bundesbank Law of 1957 and properly established the peculiar German tradition of central bank independence (Bibow, 2009, 2010). As West Germany's Basic Law ( Grundgesetz) of 1949 featured the obligation for the federal government to establish a "Bundesbank", the new Bundesbank finally superseded the BdL in 1957, reforming the latter's decentralized structures while retaining broad Länder representation on the Governing Council (Spindler et al., 1957; Hentschel, 1988).

Price stability causes economic growth, according to Bundesbank mantra. Under the peculiar conditions after the Second World War, that was actually true for West Germany. With exchange rates generally pegged to the US dollar and German inflation rates lower than in key trading partners, relative price stability boosted German competitiveness and fired the country's export-led growth (Holtfrerich, 1999). Economic growth was broad-based, as constructive labour relations secured wage growth broadly in line with productivity trends and the stability norm of 2 per cent inflation. The Bundesbank's role was that of a referee enforcing discipline upon social partners and finance ministers. The Bundesbank stood ready to slam the brakes, but refrained from stimulating domestic demand; waiting for exports to kick in instead. The model worked well for all concerned, not least the Bundesbank itself, establishing its low inflation fame without harming eco- nomic growth. West Germany became notorious for running persistent current account surpluses though (Bibow, 2013).

The model became unclenched in the 1970s with the demise of the Bretton Woods regime and oil price shocks. West German inflation rates climbed to over 6 per cent in 1973 and again in 1981, although peaking well below levels reached elsewhere. The deutschmark appreciated and gradually attained reserve currency status. Applying fiscal stimulus in the late 1970s under international pressure, West Germany had a current account deficit by 1980.

Fundamental policy changes with lasting European ramifications occurred in 1982-83. As the Bundesbank squeezed the rate of inflation back down to 2 per cent, the new gov- ernment of Helmut Kohl branded fiscal austerity and supply-side economics as West Germany's unquestioned policy wisdom. Keynesian ideas were declared obsolete. Once again, it could only work for West Germany because others behaved differently. Indeed, the European Monetary System delivered a revival of the old export-led growth model. The deutschmark became Europe's anchor currency as France adopted its "franc fort" policy in 1983 (Bibow, 2013). De facto the Bundesbank now determined European monetary policy, albeit with a legal focus on price stability in Germany (Marsh, 1992).

Both economically inefficient and politically unacceptable for Germany's European neighbours, this evolution energized the forces for deeper European integration. The idea of augmenting Europe's single market by a single currency rapidly gained strength; even more so when German unification approached. Its peculiarly powerful position both within Germany and Europe allowed the Bundesbank to dictate the conditions for abdicating its monetary reign. As a result, the "Maastricht regime" of Economic and Monetary Union (EMU) is largely of German design, with the Bundesbank serving as model for the ECB (Bernholz, 1999; James, 2012).

Today, the Bundesbank is part of the pan-European central bank system that manages the euro. Propagating Germany's price stability culture and nourishing its own reputa- tion as an inflation hawk, the Bundesbank continues to enjoy a special status not only in Germany, but also within the whole Eurosystem. Not shying away from challenging the system's supposed leader, the Bundesbank has opposed ECB decisions aimed at coun- tering renewed financial fragmentation within the euro area. The Bundesbank advised Germany's constitutional court that the ECB may be overstepping its mandate in "doing whatever it takes" to secure the euro's survival - arguably behaviour suggesting that the Bundesbank may be planning for life in Germany after the euro.

See also:

Bretton Woods regime; Central bank independence; Euro-area crisis; European Central Bank; European monetary union; Federal Reserve System.