The intellectual loneliness of Jens Weidmann, boss of the Bundesbank
from Merijn Knibbe
Is low and stable inflation more important than financial stability and should inflation be low, even at the cost of increased financial instability, like at this moment in the Eurozone where rogue flows of capital are wrecking entire countries? Seems so, according to a recent interview with Jens Weidmann, boss of the Bundesbank. But one can question the intellectual status of his ideas – they seem to be based upon thinking which lost track of main stream developments. An excerpt from the interview (emphasis in the answers added):
“So the ECB’s financial stability mandate does not mean that it has to do everything in its power to save the euro?
There is of course a close link between monetary and financial stability. Even so, price stability takes clear precedence for the ECB – it is our primary objective. Our financial stability mandate is secondary to this aim and is not a blank cheque. Central banks themselves cannot guarantee some of the conditions which allow them to fulfil their tasks; these conditions must be ensured by the governments of the member states. The central banks’ mandate also has its limits in this context.
If the ECB had not set up the government bond programme and politicians had done too little to remedy the problems, causing the crisis to escalate, wouldn’t the ECB have had to intervene anyway to stabilise the financial system?
I don’t believe that the system would have collapsed if the ECB had not set up the government bond programme. In the past, many euro-area countries coped with yields of 7% or more – not just for new bond issues but also on average. Today, the affected countries could likewise ride out higher yields on new issues for a certain length of time. In the present situation, it is vital to do what is necessary to ensure that investor confidence improves and risk premiums fall. We have to ask ourselves whether central bank bond purchases create the right incentives. The rescue packages can help us to buy time where necessary.”
These are remarkable statements. And Weidmann seems to be quite isolated when it comes to his ideas. Why?
1. Even the most ardent supporters of “inflation targeting” acknowledge that being a ‘lender of last resort’ is a prime task for central banks, too, at par with keeping inflation low and stable
The first Weidmann statement is a summary of ‘inflation targeting’, a central bank policy rooted in rational expectations economics which, when push comes to play, boils down to a ‘credible’ promise of the central bank to, if necessary, wreck the economy when medium term (expected) inflation is higher than the target. Rational expectations economics assume that fiat money neo-liberal market economies (i.e. economies with few rights for labor and large rent and seigniorage incomes for owners of capital and banks) are inherently stable and will, after external shocks or internal mistakes, return within a few years to equilibrium, as long as inflation is low and stable. And inflation will be low and stable as long as the central bank pursues credible ‘inflation targeting’, as this will cause people to adapt their behaviour to their expectations of low and stable inflations which will cause low and stable inflation which will cause expectations of low and stable inflation which will cause low and stable inflation. As long as the central bank is ‘credible’. The key idea is, to use a Robert Lucas quote, a monetary policy focused on inflation-control to the exclusion of other objectives. ‘Other objectives’ can be for instance stable economic growth, mitigating recessions and depressions, high employment or financial stability. It is assumed that, in a neo-liberal market economy, the system itself will take care of these problems, as long as inflation is low and stable. Take care: Lucas is as always kind of cunning with his definitions and in this case ‘monetary policy’ probably means ‘managing expectations’ and not so much setting the interest rate or keeping track of the monetary aggregates (to enhance my own credibility – I’m in the process of reading all the minutes of the 1979-2000 meetings of the board of governors of the Fed, which show a decreasing emphasis on variables like different kinds of inflation or the monetary aggregates, and an increasing emphasis on ‘expectations’). But even Robert Lucas admits that the role of lender of last resort is essential for central banks: “The need for a lender-of-last-resort function is one qualification to the discipline of inflation targeting, but it is a necessary one“. Which, contrary to the statement of Weidmann, means that according to Lucas it’s not a subordinated task. Joerg Asmussen, ECB board member, recently voiced the same opinion as Lucas. Weidmann’s remark seems to be at odds even with the ideas of the staunchest supporters of ’inflation targeting’. He’s on his own.
2. The monetary aggregates, considered unimportant by “inflation targeters”, turned out to be important after all…
But inflation targeting itself can be questioned too. One thing which ‘inflation targeting’ does not do is to track monetary aggregates. We are taught by monetarists that the M-2 or M-3 amount of money is the monetary aggregate to watch. Inflation targeters however assume that the amount of money will follow expectations, somehow. But just looking at the liabilities side of the balance sheet of banks ist much too simple. ‘Loans lead to deposits’ and we have to look at the loans, or the assets side of the balance sheet of banks, as well. Which brings variables like the development of total lending, of the amount of borrowing for house purchase, of the kind of borrowing (sub-prime mortgages…), of the amount of business lending and comparable metrics into our scope. These ‘counterparts’ of money growth are as or even more important that just M-2 and M-3 money, according to Charles Goodhart, in a tract which criticizes the after 1980 increasingly popular idea that money does not matter, when a bank pursues inflation targeting. Loosing track of these aggregates and the negation of the idea that money and lending and borrowing are, in the end, social variables were important reasons why central banks pursuing inflation targeting ‘did not see it coming’ and were surprised by the instability of the financial system. See, for one of many studies criticizing this,’How central banks contributed to the financial crisis‘ from Mayer and Biggs. By now, for instance the ECB and the Fed and De Nederlandsche Bank admit the possibility of ‘financial instability’ even when inflation is low and stable. But Weidmann does not take such ideas into account… He’s on his own, again.
3. Not all monetary unions are created equal. Lucas Style rational expectations ideas are based upon USA culture: there sure is a ‘counter culture’ flavor to his ideas: expectations, and not money, make the world go round. And upon the USA as a nation, with large interstate transfer and labor flows. The Eurozone has a different culture and surely is not a USA kind of nation. This excellent paper from Ulrich Bindseil and Adalbert Winkler shows that such circumstances matter: a central bank in an imperfect federation, like the ECB, has other options than the Fed, especially when it comes to the lender of last resort function. The paper was published after the interview – but as Ulrich Bindseil works at the ECB, Weidmann should have known about these ideas. But he seems to be outside of the intellectual circles were such ideas are born and nurtured.
4. Weidmann is quite wrong about the influence of interest rates on the ability of countries to cope with high government deficits, too (second statement). Weidmann states that high interest rates in Southern Europe are not really a problem. Coincidentally, the IMF just published a study which investigates exactly this problem. The conclusion:
“First, even in an environment where inflation is low, a supportive monetary environment with low real rates is important to facilitate a reduction in public debt. The monetary environment was tight in the 1980s (and in Italy until the mid-1990s) because of disinflationary efforts by central banks. As a result, debt continued to increase in all three countries (Belgium, Canada, Italy, M.K.).”
Weidmann should have known about this one, too. He’s getting paid to know such stuff. But he doesn’t seem to know. Which makes his intellectual position quite isolated. He’s on his own.