Herr Weidmann Doesn’t Get the Message

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.

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18 Responses to “Herr Weidmann Doesn’t Get the Message”

  1. 1 Olivier Braun May 8, 2012 at 12:22 am

    Dr. Glaser,

    If Hutt is correct, only unanticipated inflation would help re-coordinate the economy. Though he favored the facing of the real source of the trouble, that is as you say, the fall of the wage rates vis à vis Germany, he also proposed a “dangerous” plan : combining monetary expansion and income policies (for a stricly limited duration). Do you favour such a plan ?

    I would be afraid that the relief inflation would give would convince the politicians in charge that structural reforms (the king of Monti in Italy) are not necessary and would be election killer. See France and Greece. (but I recall Hayek also belived that deflation would force the governement to reform the economy to help the flexibility of prices, but they nevertheless didn’t do that, and Hayek then later regretted his advice).

    (I may be wrong about the necessity of unanticipated inflation, I don’t know the actual state of macroeconomic thinking. I read in a recent short piece from Leijonhufvud that the “unanticipated” is no more required.)

    Best regards.

  2. 2 Tas von Gleichen May 8, 2012 at 4:21 am

    I think anyone on this blog knows exactly what central bankers do. Therefore, we don’t have any credibility left for them whatsoever. It’s a big ponzi scheme that we happened to understand. Unfortunately, the majority of the public does not have a clue. I guess that is partly the reason why Ron Paul is not going to become President.

  3. 3 Bill Woolsey May 8, 2012 at 4:29 am

    The “unanticipated inflation” approach would require the assumption (and that is what it is, an assumption) that prices, especially wages, are at market clearing levels in Spain. Of course, with their mass unemployment there, it seems very implausible. Still, we could imagine that Spanish employers, and with Hutt, we might emphasize Spanish labor unions, would simply respond to growing demand for labor by raising wages enough to keep unemployment the same.

    If I were a Spanish political leader, I would much prefer opposing wage hikes that will choke off the recovery and return us to mass unemployment to trying to convince everyone to cut wages.

    Anyway, in my view, the key variable should not be inflation but spending on output.

  4. 4 Olivier Braun May 8, 2012 at 6:16 am

    Thank you, Mr Wolsey. But if I read Hutt correctly (I might not, I am not an economist), and on the contrary, he envisages an dis-coordinated economy, with wage rates too high to render sales at deflated prices profitable, and that is the cause of withheld capacity, unemployment and idle capital assets, and sub-optimal employment and use of assets. The input prices are not at market clearing levels and the unanticipated inflation is the « crude » (Hutt’s word, and I don’t need to point out that he disliked that means) way to re-coordinate the prices to render profitable the production at current money wages (but falling real wages). Thus, withheld capacity would be « released » and output growing again. And the source of the demand of “non-competing output” will rise again, according to his version of Say’s law, so your concern (your last sentence) would be responded to.

    The “un-anticipated inflation” would be necessary (that was my question) to prevent the labour-unions to ask for catch-up hikes. Or, to employ a income policy to prevent rises in wages (or negotiations and persuasion like Schröder did in Germany in the 2000′s, but I have no details of his reforms).

    David Glasner quote a “cryptic” phrase : “a very expansionary stance for Germany therefore has to be dealt with by other, national instruments. ” What does that mean ?

  5. 5 Bill Woolsey May 8, 2012 at 7:23 am

    Suppose the economy was in equlibrium, and suddenly, the unions force up wages. Their goal is to raise the real wages of some of their workers. The result is reduced output and employment. If there had been anticipated inflation, then the increase in nominal wages appropriate for the union bosses to implement their plan of increased real wages, would have been higher. And so, only if the inflation was unanticipated by the labor bosses would it reduce real wages, reverse the effect of the union policy, and allow production and employment to grow. But why won’t the union bosses push up nominal wages even higher to realize their planned increase in real wages?

    Now, suppose instead that the economy is in equilibrium, and nominal spending on output falls. The demand for labor falls as well and employment falls. The reduction in output and employment was not caused by a sudden increase in labor union militancy forcing up real wages. It was rather that nominal spending on output fell.

    If prices are more flexible than wages, then the reduced expenditure results in prices falling more than wages, and real wages rise. An equilibrium analysis of the firms would show that higher real wages reduce labor demand, reduce profit maximizing output, and result in market clearing prices too high for real expenditure to match the intial productive capacity.

    If nominal expenditure on output rises, we go into reverse, and prices rise more than wages, real wages fall, labor demand recovers, the firms produce more and employment recovers too.

    Now, do we assume that the “union bosses” happened to demand higher real wages when nominal expendiutres fell, so that when nominal expenditure rises again they will demand higher nominal wages to keep real wages at the temporarily high level? Perhaps, but I doubt it.

    As I said before, “we can’t afford to raise nomial wages and choke of the recovery,” is easier done than, “we need to abolish all the unions so that the employers will be free to cut your wages.”

    To summarize, Hutt is assuming that the cause of the problem was a nominal wage hike by unions aimed at raising real wages. f

  6. 6 David Pearson May 8, 2012 at 10:59 am

    “…monetary easing to ease the pain and suffering inflicted on the periphery…”

    I can’t help but note that the Euro was created to ease the pain and suffering inflicted on the periphery by monetary easing.

  7. 7 Benjamin Cole May 8, 2012 at 4:37 pm

    Excellent blogging.

    “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.” –David Glasner.

    Exactly so.

    What is this obsession, this peevish fixation—really, at this point, a perversion—for zero inflation (let along how can that be accurately measured).

    Japan has trumped Germany—it has obtained 15 percent deflation in the last 20 years.

    The only problem was that Japanese industrial production fell by 20 percent, property values by 80 percent (and still falling) and equities by 75 percent in those same 20 years.

    In the USA, from 1985 to present, industrial production doubled!!!!! Indeed production only feel coincident to deflation in 2008-10.

    Obviously, whether inflation is at 2 percent or four percent is not that important. Modern economies can thrive in that range.

    It is far from clear whether modern economies can thrive with zero inflation or deflation.

    Will the Chicken Inflation Littles ever catch on? Not likely. The need to pompously pettifog about price stability is deep in the DNA of the Chicken Inflation Littles. Every story ends up in the Weimar Republic, en route to Zimbabwe.

    No one mentions USA prosperity for decades with moderate inflation.

    Sanctimonius sermonettes about inflation have become a religion in secular Germany—at least among central bankers.

  8. 8 Julian Janssen May 8, 2012 at 5:50 pm

    This is my latest post, Money velocity versus the Keynesian multiplier, where I try to explain the difference for laypersons who are willing to listen.


  9. 9 mg May 8, 2012 at 11:28 pm

    You know a garbage piece of reasoning is coming whenever you see the phrase “no panacea,” or “no magic bullet.” Nobody says these solutions are “panaceas;” what they are saying is that they’re better than the alternative of stagnant economies and high unemployment or, under the austerity regime, shrinking economies and higher unemployment. “No panacea” is one of the many rhetorical refuges of scoundrels.

  10. 10 Olivier Braun May 9, 2012 at 12:14 am

    Mr Cole,

    It is indeed a good post, as usual with Dr. Glasner as far as I can see. But, as John H. Cochrane  wrote : « There is a lot of uncertainty in macro, both theoretical and empirical. There is a huge outpouring of serious work. How does it help at all to say your side has perfect wisdom, enshrined in a roughly 1975 vintage ISLM model, and everyone who disagrees, including Lucas, Prescott, Fama, and so forth is stupid, lying, doesn’t understand econ 1, thinks 2+2=5, or in the pay of wall street? A worthy analysis investigates how sensible people can come to both views, and then isolates which assumptions or facts they differ on. »


    Or, as the my fellow countryman Jacques de Guenin wrote in a tribute to Pascal Salin, about his benevolence : « elle permet tout simplement de se poser la question ‘tiens, comment se fait-il que tel auteur, qui me paraît pourtant intelligent et instruit, ne pense pas comme moi ?’, et même de chercher la réponse. » But should the answer lie in « obsession » ?

    I don’t like inflation for a number of reasons, not exclusively economic, and like the gold standard, and also Herr Weidmann. (I certainly read to much of Jacques Rueff). But I resent being called a « golden bug » or being « obsessed », etc. ,but I admit I may be wrong. That is one of the reasons I also like to read David Glasner’s blog, though he doesn’t dislike the use of « hyperboles » e.g. concerning the Banque de France’s policy during the late 1920′s. – and with efficacy, for he made me look at that matter. I certainly have a similar feeling when you wrote about some opponents to inflation, that for them, « every story ends up in the Weimar Republic, en route to Zimbabwe. »

    What is extremely disagreeable when you read von Mises is his tone : « every competent economist » have to think like him, if he doesn’t, he can’t be called an economist. The Austrians (some) are, alas, not alone in that line.

    William H. Hutt is a perfect example of a courteous economist, maybe one of the reasons Dr. Glasner described him as a « admirable human being ». (Maybe I am really obsessed for I can’t refrain myself from mentioning Hutt).

  11. 11 Olivier Braun May 9, 2012 at 12:50 am

    Mr Cole,
    I just followed a link in the comment section, to a post in Market Monetarism, about Dr. Schach, and a very interesting one. But here we are not, as with inflation, on the road to the Weimar Republic or Zimbabwe, but, with deflation, on the road to nazy Germany.

  12. 12 Benjamin Cole May 9, 2012 at 8:13 pm


    Thanks for your comment.

    I have to say I have been reading Cochrane’s blog, and found it to be very weak. Largely, he is reciting the usual right-wing platitudes, and passing it off as worth repeating. (I detest left-wing platitudes also, btw).

    Expect someone like Cochrane to lecture us on the evils of Solyndra, while not exploring the banality of the vast and much, much larger ethanol program.

    Cochrane has bought into the idea that the GOP is more “free market” than the D-Party, when both are dirtier than used toilet paper.

    As for inflation, I think it is secondary importance to real growth. I would thrive in the five percent real growth and five percent inflation environment, and so would my fellow citizens.

    I would not thrive in the Japan scenario, and neither would my fellow citizens.

    Pretty simple, is it not?

    Worry about what matters—real growth.

    Inflation is just a nominal index, of scant importance.

  13. 13 David Glasner May 10, 2012 at 7:18 pm

    Olivier, There are circumstances in which anticipated inflation can also re-coordinate the economy, in particular when the “equilibrium” real rate of interest is negative. “Income policy” is a very ambiguous term. It can simply mean no more than an announcement by the monetary authority that it is aiming for an increase of nominal income of a certain percentage. It can also mean that wages will be not be allowed to increase by an amount greater than the increase in nominal income plus the expected increase in productivity. In general, such policies seem to be very difficult to enforce and are hard to reconcile with liberal principles.

    Tas, I think that there are probably at least 5000 reasons that could be given for why Ron Paul is not going to become President.

    Bill, It is always difficult to compare real wages in the presence of inflation with what real wages would have been in the absence of inflation. Alchian and Kessel wrote a classic article, “The Meaning and Validity of the Inflation-Induced Lag of Wages Behind Prices.”.

    Olivier, Jens Weidmann wrote that and I have no idea what it means. In his column in Wednesday’s Financial Times, Martin Wolf quoted the same passage. Here is what he said:

    “Perhaps the most important sentence in Mr Weidmann’s article was the following: ‘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.’ In brief: if you dream that Germany will allow a credit-fuelled boom to raise domestic inflation, stop.

    David, Sorry for my provincialism, but could you provide a bit more background information. I am afraid that I, and perhaps some other readers, don’t know or can’t remember all the circumstances surrounding the creation of the euro.

    Benjamin, Another rousing call to action on your part. As usual, I will add that although more inflation (even a lot more) now would be a good thing, we should not assume that the optimal rate of inflation for the economy is constant. During periods of rapid growth, an economy could probably still thrive with deflation. Price stability over the long run is probably not a bad objective to aim for, but not to the exclusion of all other considerations.

    mg, They may not be scoundrels, but there is something eerie about how the central bankers cooperative seems to be sending out talking points to their membership and they are all staying on message.

    Olivier, Correct me if I’m wrong, but I am pretty sure that Hutt was not a supporter of the gold standard. And I agree that it was deflation that brought Hitler to power.

  14. 14 David Pearson May 10, 2012 at 9:33 pm

    The Euro was formed to create exchange rate stability between the group’s members. The idea was that this stability would increase trade and capital flows between the countries. The reason enforced stability was necessary was that the southern countries — including France — chronically inflated/devalued their way out of their fiscal problems. The idea was that enforcing German fiscal and monetary discipline across the zone would bring a true free lunch of lower credit spreads and higher economic growth.

    Of course, the Germans were not stupid. They realized that periphery countries would “free ride” on German credit spreads while returning to deficit spending. They worried the ECB might be pulled, unwillingly, into financing those deficits to prevent periphery countries from failing. This is why the Eurozone adopted strict ceilings on fiscal deficits.

    The original intent of the Euro was for Bundesbank discipline to provide a free lunch. The lunch turned out to be costly, and the German people are being presented with the tab. Given how skeptical they were at the outset, they are understandably reluctant to pay. For this, they are pilloried.

  15. 15 Olivier Braun May 11, 2012 at 12:19 am

    Thank you Dr Glasner and Mr Cole.

    I wonder if that cryptic phrase would not mean that if the ECB shall be expansionist, Germany would have to exit from the Euro (I think it was a constitutional obligation to have a stable money in Germany, and that the Federal Constitutional Tribunal ruled that Germany was allowed to ratify the Maastricht treaty, provided that if the Euro would be inflationary Germany shall quit. It is from memory and I didn’t check). Anyway, that would be a solution and would let the euro free to depreciate and wages of the periphery to fall relative to Germany.

    By the way, I read Dr. Weidmann’s paper, and have to confess it made sense to me, especially when he wrote “we have to make sure that by putting out the fire now, we are not unwittingly preparing the ground for the next one. The medicine of a near-zero interest rate policy combined with large-scale intervention in financial markets does not come without side effects – which are all the more severe, the longer the drug is administered.”

    In answer, the Economist is quoted thus : “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 isn’t that the same request as Krugman’s after the dot.com crash, asking for the creation of a housing bubble, which he got ? To “end the party” the Central Bank raises it’s rates and that trigger the recession. The old “stop an go” or better, “go and stop”.

    Krugman : “To fight this recession [the dot,com] the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” (But Arnold Kling, who pointed out that quote, later said that it was a kind of pessimistic joke from Paul Krugman).

    Link to Kling : http://econlog.econlib.org/archives/2009/06/defending_what.html#
    Krugman (last paragraph) : http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip.html

    PS : I wrote that before having seen that Robert Murphy recently discussed the Krugman quote. He thinks that Krugman was earnest. Other quotes are provided.

  16. 16 Olivier Braun May 11, 2012 at 12:32 am

    By “income policy” I had in mind a kind of price control aiming at preventing a rise in wages.

    When I wrote about the gold standard, I mentioned Jacques Rueff, not William Hutt. Indeed, as far as I have read Hutt, he didn’t advocate explicitly for the gold standard, but he seemed to have favoured the policy, after WWI, to return to the gold standard (at the pre-war parity) for moral reasons (to fulfil a solemn pledge). Anyway, he was not against a monetary policy and favoured keeping MV stable (in his jargon, to maintain the ratio M/Mr, M being the quantity of money units, Mr the value in real terms of the output) and preventing a deflation not chosen to correct a previous inflation.

  17. 17 Olivier Braun May 13, 2012 at 2:25 am

    Dr. Glasner,

    You will be glad to read that “On Wednesday, Jens Ulbrich, head of the Bundesbank’s economics department, told the finance committee of the German parliament that Germany is likely to have inflation rates “somewhat above the average within the European monetary union” in the future and that the country might have to tolerate higher inflation for the sake of rebalancing within the euro zone. Inflation would, however, only rise from a very low to a moderate level, Ulbrich said.”

    See the article in the Spiegel international :

    But some reactions are quite negative in Germany :

    I still wonder if a Germany (with Netherland and Austria and some northern countries) should not exit the euro.What do you think ? Their new currency would appreciate and that would lower the real wages of periphery countries relative to the northern block, and second, would give more room for a more expansionist monetary policy. But were should France stand ?

    Best regards.

  1. 1 Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923 « The Market Monetarist Trackback on May 8, 2012 at 11:32 am

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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