CASE STUDY 1: The Bundesbank

The Bundesbank was officially formed in July 1957. However, its history can be

traced back to World War II. The Bank Deutscher Lander was set up by the allies

after the defeat of Germany and became the Bundesbank in 1957 after the

passage of the Bundesbank Law which changed the central bank’s legal status

making the bank a federal institution and affirming its legal independence from

government.
 

The Bundesbank council comprises of Land Central Banks and Directorate,

which are all appointed by the Federal President for an eight-year term with

possible reappointment. The director is nominated by the federal government,

after consultation with the council; the Presidents of the LCBs are nominated by

the Bundesrat, the upper Federal chamber based on recommendations from the

Lander governments.

The Bundesbank mandate holds the pursuit of price stability (formally referred to

as the defense of the value of the currency) to be the primary objective.

However, there is a subsidiary obligation to offer general support to the

government’s economic policy in cases where this does not prejudice the primary

objective of price stability.

As Table 1.1 indicates, the Bundesbank has had excellent results in maintaining

price stability over a period of decades.
 
 
 
 
 
 

Table 1.1
Average Consumer Price Inflation

         1979-   1989   1990   1991   1992   1993   1994   1995   1996   1997  1998
           1988

 G      3          2.8        2.7      3.5       5.1      4.5      2.7       1.8       1.5      1.8       2
 E
 R
 M
 A
 N
 Y 1,2                                       Source: IMF World Economic Outlook May 1997
 
 
 
 
 

As to be expected, the independence status of the Bundesbank has caused

much controversy and criticism not least from German economists and

politicians. These criticism can be traced back to 1956 and notables such as

Chancellor Adenauer 3. There has been a high positive correlation between the

intensity of the criticism and restrictive monetary policy from the bank. The main

criticisms have been leveled at the policy of “high interest rates” which have

been said by many to have ruthlessly  crippled business activity. The

Bundesbank has also been accused of jeopardizing economic reconstruction in

East Germany through its policies. The increasing significance of Bundesbank

decisions on the international scene has only compounded the criticisms leveled

against its position as the total arbiter of monetary policy. At the heart of all

criticisms of Bundesbank decisions is the alleged lack of the democracy in its

mandate. This argument is simply encapsulated by the phrase, “All power within

the state comes from the people – except that of the Deutsche Bundesbank?” 4

Most theorists would agree with the premise that any institution which possesses

such far reaching powers should not operate outside parliamentary control, and it

is also unjust for a government to be held accountable for its policies in elections

when there is one large area where it has no control at all viz. that of monetary

policy.
 

Another of the criticisms aimed against the Bundesbank and for that matter all

central banks with varying degrees of goal and instrument independence is the

charge of chronic incompetence among central bank managers, who in specific

cases have allegedly made obvious mistakes and tried to pass them on as the

“art” of monetary policy. This is coupled with the public choice hypothesis that

central bankers instead of acting in the interest of the general public abuse their

office and their room for manoeuvre to pursue their own interests, even to the

detriment of the public. It is further argued that the “self – serving” central

bankers are able to hide their indiscretions from the public through a series of

complicated, impenetrable measures. In public choice terms, the independent

central bank can be regarded as the archetypal example of an uncontrolled

bureaucracy 5. The fear generated by public choice of a self – serving central

banker whose personal utility is divergent from his economic mandate is a fear

that must be taken seriously. However, one must also accept that although such

divergences are very real in theory, in practice the likelihood is that the individual

central banker’s utility is satisfied best by trying to achieve the sole goal of

monetary stability.

However, in my opinion even the possibility that an unelected independent

institution could possess the power to cripple or retard government

policy means that it is simply not enough to discuss in terms of practicality,

theoretical outcomes must also be taken seriously. Issues such as these have

brought about a call for a more accountable type of central bank system.