Paul Krugman and Simon Wren-Lewis characterise the Eurozone crisis as partly or wholly caused by German intransigence, the outcome of which is monetary and fiscal policy that is too tight, forcing an unnecessarily harsh fiscal and competitiveness adjustment on the Southern European countries. Taking the premise of this as true:
If we focus on monetary policy, one could just as well blame it on the Allied powers who enforced the Versailles Treaty on the defeated German nation at the end of World War 1. Indulging in some rather crude history: it was the impossibility of financing reparations that led to Weimar hyperinflation, and then Hitler’s take-over and subsequent determination to reverse German humiliation. And it was the experience of that hyperinflation that led Allied Powers to – with the presumed support of the German elite at the time – enshrine price stability in the constitutionally mandated framework governing the Bundesbank. That same hyperinflation coloured the Bundesbank’s conservative post World War 2 monetary policy, and the coincidence of the apparent success of that, coupled with the years of monetary-anchor-wilderness faced by the other major economies, as they worked their way through various ways of operating fiat money systems, that meant that this same constitutional price stability provision was to be hard-wired into the EU Treaty.
No doubt this history also coloured other facts, like the location of the ECB within a 5 mins Chauffeur of the Bundesbank, (something that would rebound on the Bundesbank itself, as it struggled to staff junior posts in an institution so close to its more important protoge institution); the predominance of German appointments in senior positions in the monetary policy functions of the new ECB; the early emphasis on the ‘monetary pillar’; the aversion to characterising monetary policy as being about stabilising not just inflation but real activity (which, although the rhetoric has softened, may still be colouring actual policy); the asymmetry of the inflation target [and its reluctance to call it such] which specifies that inflation shall be ‘close to but below’ 2 per cent; the fact that the ECB got to define its own objective, safely away from its coalition of political masters, an unusual example in public economics, where principals usually set their agents target, not the agent itself.
So, conjecture: don’t blame the Germans for the ECB’s conservatism. Blame Woodrow Wilson for acceding to the daft Versailles Treaty under pressure from the French premier Clemenceau. [If Keynes’ account in the ‘Consequences…’ is to be believed]. Since the EZ crisis blows back on the UK, US and of course French economies, this is a kind of karmic revenge for the overreaction of the drafters of the German ‘Basic Law’ from which the price stability clause derives.
In Mervyn King’s Ely lecture, he wrote that institutions – like independent central banks, and constitutional provisions for price stability – are a kind of social memory of past learning through experience. Let’s hope that this is right, and that future monetary and fiscal institutions governing the Eurozone correct for some of the features above which we are learning have contributed to overly conservative monetary policy.
Cue angry comments from proper financial and monetary historians…