In a leader (“Message to the Bundesbank”) in this week’s Economist, the editors gently encouraged the Bundesbank president, Jens Weidmann, to be reasonable for a change, and to tolerate marginally higher inflation than the Bundesbank has thus far been inclined to do. Some relaxation of anti-inflation fervor, the Economist counseled, will be necessary if the common European currency is to survive. Given Germany’s cost advantage, equilibrium within the Eurozone requires that wages and prices in the so-called periphery (everybody but Germany and some of its closest neighbors) fall relative to those in Germany. If the policy of the Bundesbank and its client, the European Central Bank, is to ensure that German inflation is held at near zero, wages and prices in the periphery will have to fall. That is a prescription for disaster, and for a breakup of the euro, an outcome, however desirable compared to the alternative, that no one has quite figured out a practical way to achieve. The Economist, adopting a diffident, almost deferential tone, practically begged Herr Weidmann to be reasonable.
[T]he ECB should loosen monetary conditions by cutting interest rates and, if necessary, printing money to buy bonds—even if German prices are rising faster than 2%. Instead of fighting against such easing, the Bundesbank’s proper role is to welcome this outcome. Mr Weidmann should vote for looser policy at the ECB, and then focus on minimising the fallout from higher inflation at home. . . .
[Mr. Weidmann] must be firm about the Bundesbank’s commitment to price stability, but make clear that the relevant measure is price stability in the euro zone as a whole. He should put Germany’s inflation in context: higher wages, after years of stagnation, are a good thing. And he must squash alarmist talk about asset bubbles. Yes, German property prices have started to rise, but it is hardly a bubble when house prices, relative to incomes and rents, are around 20% undervalued.
The absence of bubbles is also a reason for Mr Weidmann not to deploy macroprudential tools too soon. With no obvious financial excesses, there is little need to rein in Germany’s banks, particularly since any restrictions on them would make the euro zone’s problems harder by cutting lending to the periphery faster. If the ECB’s monetary policy stays loose for years, Germany will at some point have to worry about bubbles. But that point is a long way off. Central bankers are supposed to take the punchbowl away from the party. But not before the party has even begun.
However, in his own op-ed piece (Monetary policy is no panacea for Europe’s ills”) in Tuesday’s Financial Times, Herr Weidmann made it quite clear that he did not get (or, more likely, did not pay any attention to) the message that the Economist sent him. (If the title of Herr Weidmann’s op-ed piece sounds a bit familiar to you have a look here. Warning: it could be really, really scary.)
To overcome the crisis, short-term measures have to be consistent with the long-term stability we all strive to achieve. Overburdening monetary policy with crisis management upsets this balancing act.
In other words, don’t look to the Bundesbank of the ECB for any relief. in best central tradition, Herr Weidmann adds cryptically (i.e., incomprehensibly)
Monetary policy in the eurozone is geared towards monetary union as a whole; a very expansionary stance for Germany therefore has to be dealt with by other, national instruments.
But Herr Weidmann’s final message is anything but cryptic.
However, this also implies that concerns about the impact of a less expansionary monetary policy on the periphery must not prevent monetary policy makers taking the necessary action once upside risks for eurozone inflation increase. Delivering on its primary goal to maintain price stability is the prerequisite for safeguarding the most precious resource a central bank can command: credibility.
In other words, don’t imagine for a second that the Bundesbank and its client, the ECB, will provide any monetary easing to ease the pain and suffering inflicted on the periphery by the overriding goal of safeguarding central bankers’ credibility.