Monitory policy in Germany Bundsbank and great inflation

1990-1993
The robust output growth in West Germany that began in 1998 continued through reunification in 1990, and into 1991. The unemployment rate fell over this period, for the first time in a decade.
Reunification of course introduced new complexities for monetary management. At the time, though, the Bundesbank had two particular concerns. First the robust expansion led inflation to accelerate above the target in 1991. Second, the one-for-one currency exchange with East Germany led to a whopping 13 percent increase in the M3 aggregate within a single month. The jump complicated the problem of monetary targeting. Of greater, concern to the Bundesbank, was the possible consequence for inflation, especially given the large implicit subsidy in the currency swap.
Fear of renewed inflation induced the Bundesbank aggressively tighten. It raised short term normal rates above 9 percent. Real rate rose to the high level of the early 1980s. For the first time in the Post Britain Woods era, both normal and real rates in Germany were higher than in the U.S. One casualty of the tightening was the European monetary system. The EMS collapsed in the September 1992 due in large part to the unwillingness of other members especially UK to the keep their interest rate in line will the soaring German rates. The tightening also had predictable effects on the German economy. Due ad list in the part to monetary policy, output plummeted. WEST German industrial production dropped 15 percent from the January 1992 through September 1993. And the unemployment rate rose nearly 3 percentage points over this same period.
The recessionary economy prompted the Bundesbank to ease rates. The easing, however, was modest. While note normal and real rates declined, the level of the real rate remained high relative to earlier periods of the downturns.
Bundesbank policy in practice
The Bundesbank excessively rises short term ion interest rates in response two perceived inflationary pressures. Exception was the period 1975 to 1978 when it maintained the subnormal short term the real interest rates during a period where inflation was above the desired trend, much as the U.S was doing at the same time. Whereas some suggestions even is official Bundesbank publications, that the experience with the stagflation during this period explains why the Bundesbank has been more vigilant above the controlling inflation in the years since that time.
THE PATTERN OF THE DEVIATIONS FROM THE INFLATION and money growth targets bare in over symptomatic of implicit stabilizations component inn this in the Bundesbank policy role. The top two plans of the figure for plots target price level implied by the sequence of the target inflation rates, relative to the actual price level. The middle panel does the same for the money supply not the during the this inflation rates 1970s and early 1980s The Bundesbank persistently accommodated overshooting go the price target by simply benchmark the path for the each year, That is, it moved no attempt to target a long term path for the price level, presumably because it feared the sequences for the real economy. Generally speaking, when the price level significantly overshoots it is the target the Bundesbank pursues contractionary the policy that tends to push the money supply below the target. As we have been emphasizing, Bundesbank’s of this overshooting is evidence of the stabilization concerns. In a way, the simultaneously undershooting of the money growth target proved it one with a formal justification not to tighten further.
Conversely, in periods where the price level in significantly under the target the Bundesbank of the pushes money growth above the target. The undershooting of the price target presumably gives it leeway to ease monetary policy. In this situations we have discussed it usually cites and overvalued DM to rationalize its aims.
Identifying the Bundesbank, policy reaction, function structural VAR approach
In the previous section we developed a set of the informal conclusion about the nature if the Bundesbank policy. In this section and the next we probe the issue further by estimating policy reaction function.
In general, identifying a central bank policy reaction function involves confronting to basic complex issue. First, one has to take the set of the information to which the central; Bank response may have a primary goal of the stabilizing inflation and output.
Additional information may useful for casting future and future output good. Indeed, discussions suggests that both money supply and exchange rate are factored in to Bundesbank policy decisions in the important way.
CONCLUSIONS
So, why Germany had lower inflation than the United States and any other countries at that time. First, as discussed and pointed out above, there was political support for attacking inflation rather than economic stabilization. Second, and very importantly, Bundesbank had strategies that aimed specifically at sustaining a low inflation. Federal Reserve was dominated by a Philips curve that was not well estimated, and people that relied on it forgot that most of the points used to estimate it came from the time of the gold standard. Third, Bundesbank made a commitment that the public believed that they and Swiss Nation Bank were the dominant anti inflationists.
German monetary experiences have been interpreted in many ways. Some have seen in them a confirmation of the Quantity Theory of Money. Others have maintained that actually the experience of Germany and other during the great inflation showed that the quantity theory is not logically satisfactory for the interpretation of concrete facts, but rather that it leads to erroneous conclusions
It has been stated that, contrary to the quantity theory, prices were not the passive element in the exchange equation. Prices rose under the influence of factors outside this equation, exchange rate, and the rise of prices provoked the rise in the quantity of the circulating medium.
According to one of the professors conducting researches on this topic, Professor Mitchell quotes the example of Treasury bonds, which, according to circumstance, are simply an investment or can be used as a circulating medium. I don’t associate myself with this point of view. Rather, German experiences show us the fundamental importance in the determination of the level of internal prices and of the currency s external value, of the quantity of money issued by the Government
The best empirical demonstration of the influence of the financial and banking policy as fundamental cause of the depreciation of the mark was given by the German Government itself when it found at last, in November 1923, the necessary energy to proceed with a monetary reform. As soon as the Government issues had been stopped the exchange and price were stabilized and no external influences on the exchange equation was of effect in provoking a depreciation of the money. Thanks to rigorous control over the quantity it was possible for the German Government to keep stable the value of the rentenmark which had no gold cover

LIST OF REFERENCES

4 Other related references would be Samuelson (1974), Gordon (1975), Blinder (1979), Darby (1982) and Hamilton (1983).
5 The differences would be even more striking if one would consider a wider sample of industrialized countries (see, for example, Frenkel and Goldstein, 1999, who consider 23 countries).
To be precise: The Bank deutscher Länder was established on 1 March 1948. The D-Mark became the currency of (then) West Germany on 21 June 1948. The Bundesbank replaced its predecessor on 26 July 1957.
7 De jure the Allied Bank Commission could interfere, but never made any use of this prerogative. See Buchheim (1999).
Stefan Zweig (1970), a writer, claims in his memoirs of that time that the experience of this total loss of the value of the currency more than anything else made Germans "ripe for Hitler".
9 It was interesting to see that in the days before the Berlin Wall fell demonstrators in the streets of Leipzig carried posters saying: “If the D-Mark is not coming to us we will come to the D-Mark”. So this desire for stability had also affected the mind of East Germans.
10 It is interesting to note that "safeguarding the currency" initially referred to the "domestic" as well as the "external" value (i.e. the exchange rate) of the currency. Over time the Bundesbank succeeded in obtaining general acceptance of its interpretation of safeguarding the purchasing power of the currency.
1 See Alesina and Summers (1990). An early paper by Bade and Parkin (1980) was widely ignored and not even published.
See Deutsche Bundesbank (1974), Annual Report, p. 45.
13 In fact, the Bundesbank tried to ensure that “monetary expansion was not too great but not to small either”. See Deutsche Bundesbank (1974), Annual Report, especially p. 17.