This paper draws on earlier research in Laubach and Posen (1997), and I thank Peter Kenen and Thomas Laubach for comments on that work without in any way implicating them for what follows. The views expressed here and any remaining errors are solely my own, and not those of the Institute for International Economics.
The Deutsche Bundesbank Act of July 26, 1957 gave birth to the present German central bank. In the 40 years since, the independent Bundesbank has successfully pursued its stated goal of price stability. The future European Central Bank and several new central banks in the transition economies have been explicitly modeled upon the Bundesbank's monetary targeting framework and formal independence. Some observers have expressed fear that these new central banks will be able and inclined to single-mindedly pursue low inflation without accountability or regard for other economic objectives. The wrong lessons from the Bundesbank's experience have been taken by both sides.
According to any strict definition of targeting, the Bundesbank cannot be called a monetary targeter. Instead, the Bundesbank consciously used its announced monetary targets as a framework for signaling its intent and explaining its policies to its constituent public. The use of monetary targets in this fashion has conferred greater transparency on the Bundesbank's monetary stance. The transparency in turn has enhanced the Bundesbank's flexibility in responding to economic events, such as German reunification, rather than constrained policy. Clearly, the exercise of this flexibility has done no damage to the pursuit of price stability.
The other image associated with the Bundesbank is as the exemplar of independence from political control. Though transparency is often seen as being traded-off against that independence, this is a false view. The Bundesbank has been transparent in the most meaningful way-it has publicly announced its goal for policy over the medium term (an inflation rate of 2%), and provided the information about its policies and economic outcomes necessary for assessing its performance. The Bundesbank's experience indicates that accountability to a clear standard aids rather than hinders the independence of central banks over the long-run.
The Deutsche Bundesbank Act of July 26, 1957 gave birth to the present German central bank. The independent Bundesbank has successfully pursued its stated goal of price stability since then, notably maintaining low levels of inflation throughout the post-Bretton Woods period. On the occasion of this most highly regarded central bank's fortieth birthday-and with its semi-retirement due in less than two years with the scheduled creation of the European Central Bank - it is worth asking what lessons may be learnt from its experiences. In keeping with the celebratory nature of the occasion, I come to praise not to bury the Bundesbank. I will praise it, however, for qualities not normally attributed to it by either its admirers or its critics: the transparency and flexibility of its monetary framework. In short, I wish to offer a new interpretation of how monetary targeting has operated in Germany, and how that resulted in the successful economic performance we have seen there.
The Bundesbank has already received imitation as the highest form of praise. It is commonplace in current discussions of the future European Central Bank to hear that not only has the ECB been modeled on the Bundesbank institutionally, but that the monetary targeting strategy which the Bundesbank has pursued is a viable model for the ECB's strategy. Current European Monetary Institute President Wim Duisenberg has said that he has "....a certain preference for monetary targeting. The success of the Bundesbank shows that this strategy underpins the competence of the central bank, thus offering an optimum safeguard for its independence." (Duisenberg , p. 4) Several new central banks in the transition economies of eastern Europe and the former Soviet Union have explicitly modeled themselves upon the Bundesbank. The most-cited aspects to be emulated in all these contexts have been formal independence of the central bank from political control, a legal statement committing the central bank to price stability as the ultimate goal of policy, and the adoption of monetary targets. Some observers, seeing these developments, have expressed fear that the new central banks will be like their less positive view of the Bundesbank - too independent, able and inclined to single-mindedly pursue low inflation without accountability or regard for other economic objectives.
I would argue that the wrong lessons have been taken by both sides. In line with other recent work, I demonstrate that, according to a strict formal definition of targeting, the Bundesbank cannot be called a monetary targeter. This does not mean, however, that German inflation remained low either through blind luck or factors beyond the control of the Bundesbank. The historical record shows a different use for announced monetary targets. The Bundesbank consciously used these targets as a framework for signaling its intent and explaining its policies to its constituent public. In consequence, these targets actually granted the German central bank greater flexibility in responding to the problems of monetary control and economic shocks than would be available to an idealized monetary targeter or a central bank primarily concerned with credibility problems. The use of monetary targets in Germany has conferred greater transparency on the Bundesbank's monetary policy stances, enhancing flexibility without obvious cost to its independence.
Transparency has always been a sensitive issue for central banks, and it is one issue where the Bundesbank is not usually thought of as a leader. The image usually associated with the Bundesbank (along with the Swiss National Bank and the U.S. Federal Reserve) is as the exemplar of independence from political control, and transparency is frequently seen as being traded-off against that independence. Yet, I will argue that this is a misleading characterization both of the Bundesbank's monetary framework and of the choices confronting all central banks. The Bundesbank has been transparent in the most meaningful way - it has publicly announced its goal for policy over the medium term, defined that goal against a measurable standard, and provided the information about its policies and economic outcomes necessary for evaluating its performance in meeting that goal. The Bundesbank's experience indicates that structured transparency aids rather than hinders the independence of central banks over the long-run.
What emerges from my analysis is a characterization of German monetary practice which I have termed disciplined discretion. 1 Disciplined discretion cannot be construed merely as either a complicated hidden rule which the Bundesbank strictly follows, or as what occurs when conservative central bankers have autonomy. Disciplined discretion means a system of commitments to publicly clarify the intent and stance of monetary policy with respect to the announced goal on an ongoing basis, but freedom to set policy so long as those commitments are met. The German experience with monetary targeting leads me to conclude that it is not necessary to bind central banks' hands tightly (say by a fixed exchange rate, gold standard, or a specified rule) in order to sustain low inflation. It is crucial, however, that the central bank achieve transparency by stating its goal and provide structured accountability with respect to its meeting that goal. The Bundesbank also teaches us that flexibility and low inflation need not be in conflict.
The Bundesbank at 18: Coming of Age by Announcing Monetary Targets
The last time that German decision makers got involved in the ground stages of the design of a new monetary framework was just as the Bundesbank emerged from adolescence. At the age 16, after having been brought up under the relative stability of the Bretton Woods fixed exchange rate system, the Bundesbank had to begin making monetary decisions for itself with the system's breakdown; by its 18th birthday in 1975, the Bundesbank had in place the monetary targeting framework which it has followed to this day. It is important to emphasize that the decision to adopt monetary targeting in Germany, although prompted by the breakdown of the Bretton Woods regime, was a matter of choice. Germany certainly was under no pressure at the time to reform either its economy in general, or its monetary regime in particular - in fact, the breakdown of Bretton Woods was in part due to the extreme relative credibility of these Bundesbank's commitment to price stability, and the concomitant appreciation of the Deutsche Mark. Under these circumstances, the loss of the exchange rate anchor was not the sort of credibility crisis with macroeconomic effects demanding an immediate response, as demonstrated by the slow (two to three years long) move to the new framework.
The adoption of monetary targets by Germany in December 1974 was the beginning of a broader trend, and the US and Canada among others followed during 1975. As has been noted, there seems to be a tendency for countries to adopt explicit monetary targets in times requiring toughness on inflation (Bernanke and Mishkin , p 186), though the Germans seemed to be at least as concerned with limiting expectations once inflation began its trend down. Although there were considerable differences amongst the regimes adopted in the operations of the targets, what they all had in common was that they provided a quantified guidepost for the intended rate of monetary expansion. From reading of contemporary documents it appears that there are two principal aspects to the intellectual framework on which monetary targeting was based: the control of inflation through the control of monetary expansion, and the coordination of agents' (especially wage bargainers') expectations through the announcement of quantified policy objectives.
The emergence of inflation in the early 1970s as the predominant problem for monetary policy makers certainly had the effect to draw attention to the possible causal role of money growth in the inflationary process. As early as October 31, 1972, before the first oil shock, the Council of Ministers of the European Community passed a resolution that called for the member states to:
progressively reduce the growth rate of the [broad] money supply... until it equals that of the real [GNP], augmented by the normative price rise determined in accordance with overall economic aims and after taking account of the structural development of the relationship between money supply and national product. This target it to be reached not later than the end of 1974.
Although this resolution is silent on a number of issues, it outlines a concept of monetary targeting, based on a quantity equation, that allows for considering output as well as inflation in setting monetary policy, and specifies a fixed time horizon at which the target has to be achieved. This use of the quantity theory has been the basic procedure for monetary target setting in Germany since that time. Interestingly, the resolution foresaw the need to build in flexibility for velocity shocks ("structural development of the relationship..."), which proved too much for those other countries who attempted to strictly target without specifying their goals.
One element that is missing from the EC resolution to ears trained by 1990s discussions of monetary targeting is any discussion of public announcement of the target, or more generally any concern about the accountability of policymaking. It is important to remember that while the intellectual current of the time was running towards monetarism, and therefore in the direction of rules for monetary policy rather than of discretion, the concern for central bank credibility in the terms now much discussed had not yet been intellectually developed. The German politicians and public accepted the Bundesbank's targeting commitment without the motivation of "tieing the hands" of the central bank, or any institutional provision for that matter of oversight and accountability. Clearly, the independence of the Bundesbank, and the political coalitions which supported it, contributed to this decision. Some later observers have imposed the interpretation that one source of monetary targeting was Germans' broadly distrust of monetary discretion, but that should not be exaggerated through contemporary mindset. To most minds, that issue had already been addressed by the granting of independence to the Bundesbank in 1957, the distrust being of the politicization of monetary policy - and, obviously, the Swiss and the United States had no such memories to prompt their contemporaneous moves to similar monetary targeting. In fact, as will be shown, monetary targeting actually has conferred sizable room for discretionary policy on the Bundesbank.
The second intellectual pillar of the move to monetary targeting was a perception that medium-term inflation expectations had to be locked-in when monetary policy eased as inflation came down after the first oil shock. The generalization over time of this latter motivation-that monetary targeting provides a means of transparently and credibly communicating to wage- and price-setters the relationship between current developments and medium-term goals-was the true guiding principle of the newly adopted framework's development in Germany. It is important to recognize that, for this reason, the move to announced targets was soon accompanied by public reporting mechanisms voluntarily undertaken by the Bundesbank despite the lack of legislated requirement to do so. Beyond aiding in the coordination of expectations, the addition of efforts at transparency to the targeting framework served two other purposes as well. It contributed to the standard of democratic accountability to which the Bundesbank is held. It also gave the central bank a mechanism for publicly identifying, when shocks occurred, to which shocks policy would respond, and to which it would not. Through commitment to transparency, the Bundesbank increased its discipline without explicitly curtailing its discretion.
The actual move to monetary targeting came on December 5, 1974 when the Central Bank Council of the Deutsche Bundesbank announced that "from the present perspective it regards a growth of about 8% in the central bank money stock over the whole of 1975 as acceptable in the light of its stability goals".2 The Bundesbank considered this target to "provide the requisite scope... for the desired growth of the real economy", while at the same time the target had been chosen "in such a way that no new inflationary strains are likely to arise as a result of monetary developments". Since 1973 the Bundesbank had used the central bank money stock as its primary indicator of monetary developments, but never before had it announced a target for the growth of central bank money, or any other monetary aggregate. Although this was a unilateral announcement on the part of the Bundesbank, the announcement stressed that "in formulating its target for the growth of the central bank money stock [the Bundesbank] found itself in full agreement with the Federal Government".
The Bundesbank had always interpreted its mandate of "safeguarding the currency" under Art. 3 of the Bundesbank Act of 1957 as the requirement to give priority to the achievement of price stability in its conduct of monetary policy. During the final years of the Bretton Woods system, pursuit of this priority had been imperiled, as massive amounts of capital were flowing out of the US dollar, the destination being primarily the DM, the Swiss franc, and the currencies of those countries which were seen following most closely German monetary policy, namely Austria, Belgium, and the Netherlands. These inflows of funds, which were triggered at least in part by sluggish growth and high inflation in the US compared to Germany and Switzerland since 1968, repeatedly forced the Bundesbank to tolerate excessive money growth rates which were in conflict with its domestic objectives.
Upon release from its dollar intervention obligation on March 19, 1973, the Bundesbank immediately started to focus on reducing the free liquid reserves of the banking system, a measure for the extent to which the banking sector was able to expand its balance sheets without facing a shortage of central bank money. It was at this stage that growth in central bank money itself rather than in bank lending became the main focus of monetary policy. In a section of the September 1973 Monthly Report titled "Monetary policy through control of the central bank money supply", the Bundesbank stated that it "based its policy on the consideration that the banks' need for central bank money ultimately depends on the scale of the expansion in bank lending", and that it was prepared to make additional central bank money available "only in so far as such [provision] was consistent with its monetary policy target of reducing the inflation-induced excess money supply" (p 9).
The Bundesbank, in discussing its plan to adhere to the aforementioned October 1972 EC resolution on monetary control had remarked that
the formulation of this objective is based on the recognition that the persistent and accelerating decline in the value of money is impossible without a corresponding expansion of the stock of money held by the public and, indeed, that the monetary sphere in its own right not infrequently promotes the inflation of prices and wages. (BB 1972, p 24)
Apparently monetarism as the intellectual development of that time had a significant impact on policy makers inside the Bundesbank. It should be made clear, however, that although the Bundesbank chose to base the formulation of its annual monetary targets on the quantity theory, it was never dogmatic in its adherence to the school of thought. Current Bundesbank chief economist Otmar Issing states, "One of the secrets of the success of the German policy of monetary targeting was that...it often did not feel bound by monetarist orthodoxy as far as its more technical details were concerned."3 This statement indicates that the Bundesbank makes a link between "technical details" and monetary policy success. In other words, the visible commitment to price stability alone is not enough without the proper design of the operational framework for targeting, and that proper design requires a pragmatic approach to targeting.
The second intellectual basis invoked for monetary targeting, the coordination of the expectations of economic agents, was of particular importance at the time when the Bundesbank announced its first target.
From the immediately preceding period of fixed exchange rates [trade unions and enterprises] were accustomed to the Bundesbank's monetary policy measures becoming ineffective when they resulted in massive inflows of funds from abroad. As a consequence the Bundesbank initially failed to influence wage and price behavior in the way it wished. In the light of this adverse experience, the Bundesbank, together with the Federal Government and the independent Council of Economic Experts, concluded that it would be useful to explicitly define the 'monetary framework' for the growth of production and prices. (Schlesinger , p 6)
Although the Bundesbank's statements of the time do not make explicit mention, its primary concern with public misperceptions of monetary policy appears to have been that these misperceptions would entrench high inflation expectations.
There were first signs that the restrictive policy of the Bundesbank was beginning to slow both inflation, which had peaked at almost 8% in mid-1973, and GDP growth, when in October 1973 the first oil crisis broke. The Bundesbank's efforts to bring down inflation were thus jeopardized while at the same time output growth was expected to fall drastically. In particular, the Bundesbank was concerned that the oil price increases would quickly lead to a second-round wage-price spiral. Accordingly, by its own account "the Bundesbank endeavored to keep monetary expansion within relatively strict limits during 1974. Although it did not expressly commit itself - as it did later for 1975-to any quantitative target, it tried to ensure that monetary expansion was not too great, but not too small either" (BB 1974, p 17). Despite the fact that a quantitative target was missing, the Bundesbank was determined to communicate its message of restraint as clearly as possible.
It is of the utmost importance that in the field of price and wage policy management and labor behave in a way appropriate to the new situation. In their decisions management and labor will have to consider the fact that if the oil shortage continues, hardly more goods will be available for distribution next year than in 1973. (BB December 1973, p 7)
The Bundesbank was forcefully explaining to the public, without the benefit of explicit targets, that policy must be forward-looking and oriented towards inflation expectations. Its justification for a 'just right' monetary expansion reflected its ongoing concern for real-side effects which translated into gradual disinflation.
As it became clear that the rate of monetary expansion, as measured by the growth of central bank money, was decelerating rapidly, from April 1974 on the Bundesbank gradually eased monetary policy. At this stage the Bundesbank increasingly rationalized its policy decisions by developments in central bank money growth (see e.g. BB June 1974, pp 12-13). This gradual process culminated in the announcement in December 1974 of a monetary target of 8% growth in central bank money for 1975.
Under the influence of the growing weakness of business activity and the first signs of progress in fighting inflation, a change was made in the last quarter of 1974; the target became a slightly faster rate of monetary growth, which was publicly announced towards the end of the year. (BB 1974, p 17).
Four elements of this quote from the 1974 Bundesbank Annual Report are worth noting. First, although the Bundesbank was mostly concerned with reversing the inflationary trend of the previous five years, its new monetary policy framework still did not ignore real activity as a goal of monetary policy even in public statements. Second, the Bundesbank did not see it necessary to reverse previous price-level increases to fulfil its mandate for price stability and reduce inflation. Third, monetary policy was portrayed as acting in a pre-emptive manner ("first signs"). Finally, monetary targets were adopted at a time when inflation as well as monetary growth were expected to slow, making it easy to meet targets, but when there was also fear that easing might unleash inflationary expectations.
There was even concern that easing might give the impression that the Bundesbank's resolve to bring down inflation was diminishing. Recent experience had shown that wage setting behavior in particular was mostly unaffected by the Bundesbank's efforts to reduce inflation.
[W]age costs have gone up steadily in the last few months, partly as after-effects of [earlier] settlements... which were excessive (not least because management and labor obviously underestimated the prospects of success of the stabilization policy)... Despite the low level of business activity and subdued inflation expectations, even in very recent wage negotiations two-figure rises have effectively been agreed. (BB December 1974, p 6)
The credibility issue arose, therefore, in the context of the Bundesbank wanting to stop pass-through of a one-time shock to the price level; this concern for getting the public to distinguish between first-round and second-round effects of a price shock, to avoid lock-in of inflationary expectations, characterizes the efforts of 1990s inflation targeters as well.4 In particular, before economic research had caught up with events, the Bundesbank appeared to have seen the need for an exception to the pursuit of its long term targets in the face of the first identified supply shock. The design of a mechanism for making such an exception to the blind pursuit of price stability, and explaining use of such flexibility to the public, is an inherent challenge to all monetary frameworks. Taken from this perspective, the German monetary target seems to have been adopted, at least in part, to create a necessary means of communication about inflation uncertainty.
The Bundesbank as an Adult: Montary Targeting Operation
Since adoption in 1975, the Bundesbank has adhered to the strategy of publicly announcing numerical monetary targets and the inflation goals underlying their computation. During the first five years the procedures underwent a number of changes. Since 1980, however, the operational framework of German monetary targets has displayed a remarkable degree of continuity. Most impressively, overshootings of the target range in recent years, as well as a decision to change the monetary aggregate targeted after a large velocity shock, were managed without a persistent rise in inflation or inflation expectations.
The literature on the conditions under which an economic variable constitutes a good intermediate target for monetary policy is too voluminous to be fully summarized here;5 for purposes of this discussion, it is more important to deflate the myth that Germany actually set policy solely on the basis of a monetary target at any time.
Strictly defined, the use of a money growth target means that the central bank not only treats all unexpected fluctuations in money as informative...but also, as a quantitative matter, changes the interest rate or reserves in such a way as to offset these unexpected fluctuations altogether...and thereby restore money growth to the originally designated target rate. (Friedman , pp. 5-6)
As will be seen, although the results of announcing monetary targets, and making use of the information in them, in Germany would lead to a positive judgment for its targeting frameworks, the Bundesbank does not strongly resemble the idealized picture of a monetary targeter.
In particular, the historical record demonstrates that German monetary policymaking did not behave as though price stability were its sole (short- to medium-term) policy goal, or as though the monetary growth-inflation correlation were strong enough to justify strictly following the targets while ignoring wider information.6 In fact, the manner in which the Bundesbank conducted policy under the targets implies that monetary targets provide a framework for the central bank to convey its long-term commitment to price stability irrespective of strictness of adherence to the target itself.
From 1975 until 1987 the Bundesbank announced targets for the growth of the central bank money stock (CBM). CBM is defined as currency in circulation plus sight deposits, time deposits with maturity under four years, and savings deposits and savings bonds with maturity of less than four years, the latter three components weighted by their respective required reserve ratios as of January 197s4. Since 1988, the Bundesbank has used growth in M3 as its announced target. Apart from not including savings deposits with longer maturities and savings bonds, the major difference between M3 and CBM is that the latter is a weighted sum aggregate while the former is a simple sum. The only source for large divergences between the growth of the two aggregates are significant fluctuations in the holdings of currency as compared to deposits. This potential divergence became critical in 1988 in the face of shifting financial incentives (leading to the switch in target aggregates), and again in 1990-91 after German monetary unification.
The Bundesbank has always set its monetary targets at the end of a calendar year for the next year. It derives the monetary targets from a quantity equation, which states that the amount of nominal transactions in an economy within a given period of time is identically equal to the amount of the means of payment times the velocity at which the means of payment changes hands. In rate-of-change form, the quantity equation states that the sum of real output growth and the inflation rate is equal to the sum of money growth and the change in (the appropriately defined) velocity. The Bundesbank derives the target growth rate of the chosen monetary aggregate (CBM or M3) by estimating the growth of the long-run production potential over the coming year, adding the rate of price change it considers unavoidable, and subtracting the estimated change in trend velocity over the year.7
Two elements of this procedure deserve emphasizing. First, the Bundesbank does not employ forecasts of real output growth over the coming year in its target derivation, but instead estimates of the growth in production potential.8 This "potential-oriented approach" is based on the Bundesbank's conviction that it should not engage in policies aimed at short-term stimulation. Not only does this let the Bundesbank claim that it is not making any choice about the business cycle when it sets policy, but it also allows the Bundesbank to de-emphasize any public discussion of its forecasting efforts, even when they might involve reestimating or admitting ignorance of the NAIRU, further distancing monetary policy from the course of unemployment. The transparency of the quantity approach therefore gets certain items off of the monetary policy agenda (or at least moves in that direction) by specifying what the central bank is responsible for.
The second element is the concept of "unavoidable price increases", where prices are measured by the all-items CPI. These goals for inflation are set prior to the monetary target each year, and specify the intended path for inflation which motivates monetary policy.
In view of the unfavorable underlying situation, the Bundesbank felt obliged until 1984 to include an "unavoidable" rate of price rises in its calculation. By so doing, it took due account of the fact that price increases which have already entered into the decisions of economic agents cannot be eliminated immediately, but only step by step. On the other hand, this tolerated rise in prices was invariably below the current inflation rate, or the rate forecast for the year ahead. The Bundesbank thereby made it plain that, by adopting an unduly "gradualist" approach to fighting inflation, it did not wish to contribute to strengthening inflation expectations. Once price stability was virtually achieved at the end of 1984, the Bundesbank abandoned the concept of "unavoidable" price increases. Instead, it has since then included... a medium-term price assumption of 2%. (Deutsche Bundesbank , pp 80-81)
The setting of the annual "unavoidable price increase" thus embodies four normative judgments by the Bundesbank: first, that a medium-term goal for inflation motivates forward-looking policy decisions; second, that convergence of inflation to the medium-term goal should be gradual, since the costs of reaching that goal cannot be ignored; third, that the medium-term goal of price stability is operationally defined as a measured inflation rate greater than zero; and fourth, that if inflation expectations remain contained there is no need to reverse prior price level rises. These aspects of the announced inflation goal, and the fact that the goal is announced, embody the true basis of the German monetary framework.
The target for 1975 was a point target for CBM growth from December 1974 to December 1975. Since this target definition was susceptible to short-term fluctuations in money growth around the year end, the targets for the years 1976 to 1978 were formulated as point targets for the average growth of CBM over the previous year. In 1979, two lasting changes to the target formulation were made. First, with the exception of 1989, all targets have been formulated in terms of a target range of plus-or-minus 1 or 1.5% around the monetary target derived from the quantity equation.
In view of the oil price hikes in 1974 and 1979-80, the erratic movements in 'real' exchange rates and the weakening of traditional cyclical patterns, it appeared advisable to grant monetary policy from the outset limited room for discretionary maneuver in the form of such target ranges. To ensure that economic agents are adequately informed... the central bank must be prepared to define from the start as definitely as possible the overall economic conditions under which it will aim at the top or bottom end of the range. (Schlesinger , p 10)
Again discretion and transparency were advanced in tandem. In moving to a target range rather than a point target, the Bundesbank believed that by giving itself room for response to changing developments it could hit the target range; in fact, the tone of its explanation is that it was conferring some discretion upon itself rather than buying room for error in a difficult control problem. This could reflect actual stability of monetary demand and transmission mechanisms in Germany, or the absence of fears there at the time about central bank error. The second change was that the targets were formulated as growth rates of the average money stock in the fourth quarter over its counterpart in the previous year, in order to indicate "the direction in which monetary policy is aiming more accurately than an average target does" (BB January 1979, p 8). This redefinition also tied an increase in flexibility to greater clarity.
To drive home the obvious, the Bundesbank "has never left any doubt that it not only wholeheartedly accepts the special responsibility for combating inflation which the legislature has assigned to it but also regards this as an economically meaningful role for an up-to-date central bank to play." (Deutsche Bundesbank , p 23) The strictness of this view is supported by the fact that the Bundesbank has set its monetary policy agenda by working from the underlying inflation goal through the quantity equation as discussed above.
At the same time, however, the Bundesbank has repeatedly stressed that situations may arise in which it would consciously allow deviations from the announced target path to occur in support of other economic objectives. These allowances remember are beyond and in addition to those implicit in the setting of a target range and of a gradual path for movements in unavoidable inflation. A case in point is the year 1977, when signs of weakness in economic activity combined with a strong appreciation of the DM prompted the Bundesbank to tolerate the monetary target being overshot. As said at the time,
However, the fact that the Bundesbank deliberately accepted the risk of a major divergence from its quantitative monetary target does not imply that it abandoned the more medium-term orientation which has marked its policies since 1975... there may be periods in which the pursuit of an 'intermediate target variable', as reflected in the announced growth rate of the central bank money stock, cannot be given priority. (BB 1977, p 22)
In other words, the target cannot be slavishly adhered to as crises arise and circumstances change. This situation is inherent to the any targeting framework and cannot be removed by redefining the target aggregate, so long as the central bank does not totally ignore the short-run effects of unforeseen shocks-and neither the Bundesbank nor any other central bank has in the postwar era.
In fact, the main reason why CBM was initially chosen as target aggregate was the Bundesbank's perception of its advantages in terms of transparency and communication with the public. The Bundesbank explained its choice of CBM in the following words:
[CBM] brings out the central bank's responsibility for monetary expansion especially clearly. The money creation of the banking system as a whole and the money creation of the central bank are closely linked through currency in circulation and the banks' obligation to maintain a certain portion of their deposits with the central bank. Central bank money, which comprises these two components, can therefore readily serve as an indicator of both. A rise by a certain rate in central bank money shows not only the size of the money creation of the banking system but also the extent to which the central bank has provided funds for the banks' money creation. (BB 1975, p 12)
Although at any point in time the central bank money stock is a given quantity from the Bundesbank's point of view due to the minimum reserve requirements, it nevertheless also reflects the monetary policy stance in the recent past. It is worth noting that this tracking of monetary stance is consistent with the Bundesbank's fixation on minimum reserve requirements (as seen in their advocacy for such for the unified European currency). The information being conveyed here, however, is not so much to avoid either the public or the central bank making a large mistake about the unclear stance of monetary policy (a major concern in framework design of later inflation targeters, such as Canada), but to give rapid feedback about the state of monetary conditions in general. The mindset is that monetary control gives a position of informational strength to policy, rather than seeing policy as a source of uncertainty.
In 1986 and 1987, a strong DM combined with historically low short-term interest rates led to above target CBM growth of 7.7% and 8% respectively, while M3 grew at 7% and 6% during those two years. This development prompted the Bundesbank to announce a switch from 1988 on to monetary targets for the aggregate M3.
The expansion of currency in circulation is in itself of course a significant development which the central bank plainly has to heed. This is, after all, the most liquid form of money ... and not least the kind of money which the central bank issues itself and which highlights its responsibility for the value of money. On the other hand, especially at times when the growth rates of currency in circulation and deposit money are diverging strongly, there is no reason to stress the weight of currency in circulation unduly.9
The fact that the Bundesbank changed the target variable when CBM grew too fast, but did not do so when it grew too slowly (as it did in 1981 and early 1982), can be interpreted as an indication of the importance that the Bundesbank attaches to the communicative function of its monetary targets; allowing the target variable to repeatedly overshoot the target because of special factors might have led to the misperception on the part of the public that the Bundesbank's attitude towards monetary control and inflation had changed.10
The Bundesbank's confidence that it can explain target deviations and redefinitions to the public is reflected in the design of its reporting mechanisms. There is no legal requirement in the Bundesbank Act or in later legislation for the Bundesbank to give a formal account of its policy to any public body. Independence of the central bank in Germany limits government oversight to (Act Section 13) a commitment that "The Deutsche Bundesbank shall advise the Federal Cabinet on monetary policy issues of major importance, and shall furnish it with information upon request." The only publications which the Bundesbank is required to produce are (Act Section 33) announcements in the Federal Gazette of the setting of interest rates, discount rates, and the like. According to Act Section 18, the Bundesbank may at its discretion publish the monetary and banking statistics which it collects. Any accountability, and therefore legitimacy, which the Bundesbank retains for the exercise of its independence rests upon what use the Bundesbank makes of its voluntary communications.
The Bundesbank chooses to make heavy use of this opportunity. The Monthly Report is claimed inside the front cover to be a response to Section 18 of the Act, but does much more than report statistics. Every month, after a "Short Commentary" on monetary developments, securities markets, public finance, economic conditions, and the balance of payments, two to four articles on a combination of one-time topics ("The state of external adjustment after German reunification") and recurring reports ("The profitability of German credit institutions" annually, "The economic scene in Germany in") are published. Each year in January the monetary target and its justification is printed (in December from 1989 to 1992). The Annual Report gives an extremely detailed retrospective of the economic, not just monetary, developments in Germany for the year, as well as listing all monetary policy moves and offering commentary on the fiscal policy of the Federal Government and of the Länder. The vast variety and depth of information provided by the Bundesbank in its Reports would appear to be evidence that a wide range of information variables, far beyond M3, velocity, and potential GDP, plays a role in Bundesbank decision-making (the work involved in producing the data and analysis makes it unlikely that it is merely a smokescreen or a public service). Nevertheless, monetary policy moves are always justified with reference to M3 and/or inflation developments, not these other types of data. Between these two publications, and regularly updated "special publications" such as The Monetary Policy of the Bundesbank (an explanatory booklet), no Bundesbank policy decision is left unexplained both specifically and against the larger context.
The Bundesbank's commitment to transparency does not come without self-imposed limits to its accountability. Two limitations in particular provide a strong contrast to the inflation report documents prepared by Canada, the United Kingdom and others in recent years. First, no articles in the Monthly Report are signed either individually or collectively by authors, and the Annual Report has only a brief foreword signed by the Bundesbank president (although all Council members are listed on the pages preceding it); speeches by the President or other Council members are never reprinted in either document. This depersonalization of policy is to some extent made up for by the enormously active speaking and publishing schedule which all Council members (not just the President and Chief Economist) and some senior staffers engage in, but it still distances the link between the main policy statements and responsible individuals.
The second limitation on accountability is that the Reports always deal with the current situation or assess past performance11 -no forecasts of any economic variable are made public by the Bundesbank, and private-sector forecasts or even expectations are not discussed. The Bundesbank makes itself accountable on the basis of its explanations for past performance, but does not leave itself open to be evaluated as a forecaster. In fact, its ex post explanations combined with its potential GDP and normative inflation basis for the monetary targets enable the Bundesbank to always shift responsibility for short-term economic performance onto other factors.
Nevertheless, those same monetary targets are seen by the Bundesbank as the main source of accountability and transparency because they commit the Bundesbank to having to explain policy with respect to a benchmark on a regular basis. Moreover, that explanation of policy to the public is given at length, and with respect to the whole economy (not just monetary developments). This is an explanatory impulse beyond the deceptively uninformative question of whether or not a specific target was met at the prescribed time.
The Bundesbank at 32: The Mid-Life Crisis of Reunification
The greatest challenge to German monetary policy since the adoption of monetary targeting followed the fall of the Berlin Wall in 1989. The Bundesbank's response to the shock of reunification illustrates the exercise of disciplined discretion developed in this paper. The economic situation in the Federal Republic during the two years prior to economic and monetary union with the former GDR on July 1, 1990 (henceforth "monetary union") was characterized by GDP growth of around 4% and the first significant fall in unemployment since the late 1970s. After a prolonged period of falling inflation and historically low interest rates during the mid-1980s, inflation had increased from -1% at the end of 1986 to slightly over 3% by the end of 1989. The Bundesbank had begun tightening monetary policy in mid-1988, raising the repo rate in steps from 3.25% in June 1988 to 7.75% in early 1990. After the first M3 target, for 1988, of 3-6% had been overshot by 1%, the target for M3 growth of around 5% in 1989 was almost exactly achieved, with M3 growing at 4.7%. M3 growth was certainly not high in view of the prevailing rate of economic growth.
In response to the uncertainties resulting from the prospect of German monetary union, long-term interest rates had increased sharply from late 1989 until March 1990, with 10-year bond yields rising from around 7% to around 9% in less than half a year. Combined with a strong DM this prompted the Bundesbank to keep official rates unchanged during the months immediately preceding monetary union. In the immediate aftermath it did so as well, despite the fact that the effects of the massively expansionary fiscal policy accompanying unification were beginning to propel GDP growth to record levels.
To some extent the Bundesbank's decision to keep interest rates unchanged for the first months following monetary union was due to the fact that the inflationary potential resulting from the conditions under which the GDR mark had been converted into DM was very difficult to assess. The Bundesbank had been opposed to the conversion rate agreed to in the treaty on monetary union, (overall about 1:1.8) and had been publicly overruled on this point by the Federal Government.12 The money stock M3 had increased due to monetary union by almost 15%. This number turned out to be almost exactly right, for while GDP in the former GDR was surprisingly estimated to be only around 7% of the Federal Republic's ex post, with the government's transfers to the east, all of the money was absorbed (see König and Willeke ). During the first few months following monetary union the Bundesbank was preoccupied as well with assessing the portfolio shifts in east Germany in response to the introduction not only of a new currency, but also of a new financial system and a broad range of assets which had not existed in the former GDR.
As the eastern German banks were adjusting to their new institutional structure, and velocity was destabilized by the portfolio shifts of 15 million new capitalists, monetary data including eastern Germany were hard to interpret. The Bundesbank therefore continued during the second half of 1990 to calculate monetary aggregates separately for east and west Germany, based on the returns of the banks domiciled in the respective parts. Although M3 growth in west Germany accelerated in late 1990, as a result of the moderate growth rates during the first half of the year, growth of west German M3 during 1990 of 5.6% was well within the target of 4-6%.
During the fall of 1990 the repo rate had approached the lombard rate, which meant that banks were increasingly using the lombard facility for their regular liquidity needs, and not as the emergency facility as which the Bundesbank intended lombard loans to be used. On November 2, 1990 the Bundesbank raised the lombard rate from 8 to 8.5%, as well as the discount rate from 6 to 6.5%. Within the next few weeks, however, as a result of the way that banks were bidding the interest rate, the repo rate rose above the lombard rate, prompting the Bundesbank to raise the lombard rate to 9% as of February 1, 1991. With these measures the Bundesbank was reacting to both the tempestuous GDP growth rates as well as the faster M3 growth in the last part of 1990. Inflation had so far remained fairly unchanged, but it seems likely that the Bundesbank was at that point expecting inflationary pressures to develop in the near future, given the fiscal expansion, the overstretched capacities in west Germany, and the terms of monetary union.
At the end of 1990 the Bundesbank announced a target for M3 growth of 4-6% for the year 1991, applying a monetary target for the first time to the whole currency area. The target was based on the average all-German M3 stock during the last quarter of 1990. As this stock was likely to be still affected by ongoing portfolio shifts in east Germany, the target was subject to unusually high uncertainty. It is worth noting that neither of the basic inputs into the Bundesbank's quantity equation which generates its money growth targets, "normative inflation" nor the potential growth rate of the German economy, were changed.
Following German unification, the monetary targets set by the Bundesbank were decidedly ambitious as they left normative inflation, on which these targets are based, unchanged at 2% during this period, even though it was obvious from the outset that this rate could not be achieved in the target periods concerned. (Issing [1995b])
The maintenance of the inflation target was a statement of policy that the reunification shock did not fundamentally alter the basic structures of the German economy. Moreover, this was a communication to the public at large that any price shifts coming from this shock should be treated as one-time event, and not be passed on into inflationary expectations.
This required faith in the public's comprehension of, and the Bundesbank's ability to credibly explain, the special nature of the period. It is important to contrast this standing by the two percent medium-term inflation goal with the Bundesbank's response to the 1979 oil shock, when, as already noted, unavoidable inflation was ratcheted up to 8 percent, and brought down only slowly. Two not mutually exclusive explanations of this difference in the 1990-93 period are that the shock was a demand rather than a supply shock, and so the Bundesbank was correct not to accommodate it, and that, after living through monetary targeting for several years including the oil-shocks, the Bundesbank's transparent explanations of monetary policy had trained the public to discern the differences between one-time and persistent inflationary pressures. In any event, the Bundesbank clearly was nuancing its short-term monetary policy in pursuit of the longer-term goal.
Following the Bundesbank's target announcement, in which it stressed its continued adherence to monetary targeting after unification, and the lombard rate increase on February 1, long-term interest rates started falling for the first time since 1988. With hindsight, it becomes apparent that this was the beginning of a downward trend continuing until the bond market slump in early 1994. Although the highest inflation rates were still to come, apparently at this point financial markets were convinced that the Bundesbank would succeed in containing, if not reducing, inflation in the long run. Through its transparency of making it clear that it would not accommodate further price rises in the medium-term, the Bundesbank bought itself flexibility for short-term easing without it being misinterpreted. This link of transparency enhancing flexibility of course depends upon the central bank's commitment to price stability being credible, but it emphasizes how even a credible central bank may gain through institutional design to increase transparency.
Until mid-August of 1991 the Bundesbank left the discount and lombard rates unchanged, while the repo rate steadily edged up towards the lombard rate of 9%. CPI inflation in west Germany had still remained around 3% during the first half of 1991, while GDP growth in west Germany remained vigorous. M3 growth, by contrast, was falling as compared to its upward trend during late 1990, caused to some extent by faster than expected portfolio shifts into longer-term assets in east Germany. These portfolio shifts, as well as the sharper than expected fall in east German production potential, led the Bundesbank for the first time ever to change its monetary target on the occasion of its mid-year review. The target for 1991 was lowered by 1% to 3-5%. The rarity of resetting the monetary target is critical to such adjustments being accepted without being seen by the public as a dodge wherein the central bank resets goals to match results. In this instance, the Bundesbank was able to invoke its implicit escape clause of the semi-annual review, and, through that formalized process demanding a clear explanation, justify their adjustment. The discipline of the monetary targeting framework displayed its disadvantage as well, i.e., the difficulty if not impossibility of money demand being stable, or at least the necessary changes in its relationship to goal variables being seen ex ante.
Despite the fact that GDP growth started to slacken during the second half of 1991, M3 growth accelerated. To some extent the faster growth of M3 was a result of the by then inverted yield curve, which led to strong growth of time deposits and prompted banks to counter the outflow from savings deposits by offering special savings schemes with attractive terms. This was the first time that the yield curve had turned inverted since the early 80s, and the first time since the Bundesbank had been targeting M3. In this situation, the conflict arose for the Bundesbank that interest rate rises were likely to foster M3 growth. This problem was all the more acute since banks' lending to the private sector was growing unabated despite the high interest rates, probably to a large extent due to loan programs subsidized by the Federal Government in connection with the restructuring of the east German economy and housing sector.
This conundrum of the Bundesbank's instrument tending to work in the "wrong" direction, brought the underlying conflict of monetary targeting to the fore - the target must be constantly critically evaluated for its relationship to the ultimate goal variable(s), yet if it is constantly cast aside with reference to changes in that relationship, or special circumstances indicating a role for other intermediate variables, it ceases to be a target rather than an indicator.
Strictly defined, the use of a money growth target means that the central bank not only treats all unexpected fluctuations in money as informative in just this sense, but also, as a quantitative matter, changes its instrument variable in such a way as to restore money growth to the originally designated path. (Friedman and Kuttner , p 94)
The acceleration in late 1991 notwithstanding, M3 grew by 5.2% during 1991, close to the mid-point of the original target, and just slightly above the revised target.
On December 20, 1991 the Bundesbank raised the lombard and discount rates by another 0.5%, to 9.75% and 8% respectively, their highest level since the Second World War (if the special lombard rates from the early 1970s are disregarded).
In the light of the sharp monetary expansion, it was essential to prevent permanently higher inflation expectations from arising on account of the adopted wage and fiscal policy stance and the faster pace of inflation - expectations which would have become ever more difficult and costly to restrain. (BB 1991, p 43)
The rhetoric invoked here by the Bundesbank is important to appreciate. Both government policies and union wage demands could be (and were) cited for their inflationary effects, that is their pursuit of transfers beyond available resources. The Bundesbank may not have been able to override Chancellor Kohl's desired exchange rate of Ostmarks for Deutsche marks, or his "solidarity" transfers, but the Bundesbank Direktorium was comfortable making it clear that his government and not they should be held accountable for the inflationary pressures; the Direktorium did take on accountability for limiting the second-round pass-through effects of these pressures. In addition to this division of accountability, the Bundesbank also clearly expressed some concern for persistence of inflationary expectations and the cost of (if necessary) disinflating them, thereby making clear some assumptions about the realities of monetary transmission. Finally, the Bundesbank's emphasis on the ultimate goal-medium-term price stability and inflation expectations-does not lead them to directly cite measures of private-sector expectations, something which we will see many inflation targeters began doing at this time.
The December 20 increase in the lombard rate proved to be the last one. During the first half of 1992 the repo rate slowly approached the lombard rate and peaked in August at 9.7% before starting to fall from late August onwards, as the Bundesbank started to ease monetary policy in response to appreciation of the Deutsche Mark, and the emerging turbulences in the European Monetary System; of course, this move also coincided with the rapid slowdown in German GDP growth as well. The monetary targets would for 1992 and 1993 would not be met, but the challenge to German monetary policy was over.
Thus in 1992, for example, when the money stock overshot the target by a large margin, the Bundesbank made it clear by the interest rate policy measures it adopted, that it took this sharp monetary expansion seriously. The fact that, for a number of reasons, it still failed in the end to meet the target...has therefore ultimately had little impact on the Bundesbank's credibility and its strategy. (Issing [1995a])
Monetary policy transparency was explicitly linked to flexibility during reunification, at least according to the Bundesbank's chief economist-and that flexibility was exercised to minimize the real economic and the political effects of maintaining long-term price stability.
The Bundesbank at 40: Lessons Before Early Retirement
While the record of success of the Bundesbank's targeting strategy since the collapse of the Bretton Woods regime is indeed impressive, the lessons to be learnt from it are not those commonly held. The primary benefits gained from announced monetary targets in Germany are from the transparency which this framework confers on the exercise of discretionary policy - strict adherence to monetary aggregate growth as a formal intermediate target, and the rule-like constraint on policy that would imply, has not played a role in the Bundesbank's success. To cite one topical implication, interpretations of German monetary targeting which imply that there is an inherent conflict between the future European Central Bank's independence and some efforts to close the "democratic deficit" of the ECB's accountability, or that the future ECB would need to blindly pursue price stability in order to maintain its credibility, are mistaken. Putting the lessons from the Bundesbank's forty years in more general terms:
1. Monetary targets were never the actual target of or even sole guide to policy - As discussed above, the announced monetary targets were never slavishly followed in the sense of being an actual intermediate target variables in Germany. It is well-known that annual target ranges were missed around fifty percent of the time in Germany in the 1980s and 1990s. Far more significantly, the Bundesbank has, by its own account and as seen in the historical record, taken into account a much broader range of information than just money when setting policy. When inflation and monetary forecasts have diverged, the Bundesbank has responded to the former. Moreover, the Bundesbank has responded to a number of short-run shocks and challenges even when they have not directly affected inflation or money13.
2. The key function of the targets was to transparently convey the goal of policy -Instead of use as targets per se, the primary gains from announced monetary targets have been through their use as a framework for transparent indication of monetary policy stance and intentions with reference to an underlying but public numerical inflation target. The ability to have a standard and a goal for forward-looking policy to point to amongst the chaos of present day decisions seems to anchor public expectations. Unavoidable deviations from the medium-term goal which arise may then be explained with reference to that standard. This is the reason why the Bundesbank's framework, for all its legal independence and its accumulation of prestige and support over the last 40 years, includes institutionalized structures for providing explanations of policy in an explicit and informative manner on a regular basis. The Bundesbank found very shortly after adopting targets that simply announcing the monetary target and interest rate numbers alone was insufficient without a concerted effort to give greater information about the stance of policy based on the inflation goal and the distance to it.
3. Transparency about monetary policy's goal and the progress towards it does not compromise independence - Although the Bundesbank has been subject to little formal accountability to the electorate or to elected officials in the explicit manner of the Federal Reserve, let alone of the Reserve Bank of New Zealand, it has issued a constant stream of statements delineating its decisions, its reasoning, its responsibilities and its performance. Most importantly, it clearly defines its goal in numerical terms and states it publicly. A central bank which appears before legislative committees without a clear standard to which to be held is in fact less accountable. Without a clear standard of evaluation, a central bank not only leaves uncertainty about its goals, it gains less from its successes, and loses the opportunity to build support from its performance. I have argued previously that central bank independence over the long-run is impossible without political support, whatever the legal situation, and, as the Bundesbank's outreach efforts indicate, even where explicit oversight does not exist de jure independent central banks will act in line with this reality14. Such voluntary accounting may not be enough to fully close the perceived democratic deficit of the Maastricht treaty protected European Central Bank15 - the fact that no conflict exists between such accountability and independence should not be lost, however, amidst calls for further efforts at democratic control.
4. Transparency enhanced the discretion of policymakers to act flexibly - Not only does the Bundesbank's targeting framework give wage- and price-setters a better awareness of monetary policy's stance at any given time, it allows the Bundesbank to distinguish in the public's mind between one-time price-level shifts and other shocks which would require a response irrespective of pass-through. We saw this flexibility tied to transparency exercised by the Bundesbank during German reunification and in the face of a number of exchange rate swings. In a transparent framework where this information is provided, changes in target levels and even target misses have not only proved to have only limited fallout, they have served an educational function. When the Bundesbank moved its "unavoidable inflation" target to 4% in 1980, it informed the public that supply shocks do require a different response than demand shocks, and that there is room for gradualism in disinflation; when the Bundesbank re-named its inflation target of 2% the "normative rate of price increase" in 1986, it indicated what level of inflation could function as an operational definition of price stability (and why that was not zero) as well as its likely future stance. There appears to be a positive synergy between having to occasionally break the commitment to the targets and low inflation in the short-run - and then explaining the deviation - and public support for and understanding of that commitment over the long-run.
5. Flexibility in the face of economic events is not damaging to price stability - In fact, while the Bundesbank does not have an explicit numerical 'escape clause' with legal standing, a la New Zealand, to allow release from target obligations in the face of severe financial or supply shocks, it has exercised that flexibility as though it were there. That flexibility is in addition to the full advantage the Bundesbank takes of the flexibilities built into its target definition by having a target range and assessing whether the trend of monetary growth falls in it. This flexibility should not come as a surprise to careful observers of the Bundesbank, but it is worth re-emphasizing that even the supposedly tight German monetary targeting framework has allowed for such responsiveness when so many seem to fear that a central bank would suffer for any deviations from its mandate for price stability. The importance of written charter mandates for central banks has generally been exaggerated. There is no evidence that a negative correlation exists between a central bank's legal mandate and the country's average inflation level (it should be remembered that, in contrast to the Bundesbank, both the Swiss National Bank's and the Federal Reserve's written mandates are for many goals, not just price stability, yet their average national inflation rates have also been low). Binding a central bank's hands extremely tightly does not seem to be a necessary condition for sustained low inflation.
6. Pursuit of price stability need not be a crusade to be successful - The record of policies and performance of the Bundesbank demonstrates as well that the achievement of practical price stability does not require obsessive pursuit of anti-inflationary policies. Germany has shown that a country need not drive inflation all the way down to zero measured change in the CPI - or even make that the announced goal - in order to avoid inflationary pressures. When inflationary shocks have occurred, the Bundesbank has disinflated gradually out of consideration for the effects of its policies on real economic performance. As seen in the aftermath of the 1979 oil shock, such gradualism has proved no impediment to the containment of German long-term inflation expectations. Given these results, Germany has never found it necessary or in any way advantageous to reverse past inflations to return the price-level to its pre-shock level.
As the Bundesbank at the ripe age of 40 looks towards its early retirement we should recognize the main points it has to teach us: that practical price stability can be achieved without unnecessary anti-inflationary zeal and inflexibility; and that transparent public discussion of monetary policy aids both the accountability and the performance of monetary policy rather than sacrificing one for the other. Therefore, the future European Central Bank and other central banks interested in emulating the Deutsche Bundesbank's performance - both in terms of sustained low inflation and of consistent public support for the central banks' policies - might best turn their attention to the manner in which policies are operationally implemented and conveyed to the public, rather than to more abstract concerns about "credibility." The practice of disciplined discretion in monetary policymaking as exemplified by the Bundesbank is not to put a rule-like coat of rationalizations on ad hoc policies, but to create the proper balance between flexibility and transparency in the operation of monetary policy. Central banks which emulate the Bundesbank's form without the substance of announcing a specified goal and transparently providing the means to assess progress towards that goal will not achieve the Bundesbank's true independence and performance.
1. This term was coined in Laubach and Posen (1997), which gives a more detailed analysis of the development of German monetary targeting and of the comparable Swiss framework.
2. The announcement is reprinted in BB December 1974, p. 8. (References to signed articles in the central banks' serials are included in the bibliography. References to unsigned articles in central bank serials are given in the text as follows: Quotes from Annual Reports of the Deutsche Bundesbank are referred to as BB; quotes from the Monthly Reports of the Deutsche Bundesbank are referred to as BB.
3. Issuing (1995b). He accepts the characterization of the Bundesbank's monetary policy approach as "pragmatic monetarism" in Issing (1995a).
4. This was seen in the Canadian adoption of inflation targeting at the start of 1991, after a couple years of disinflationary policies and at the time of a one-time rise in inflation due to an increase in indirect taxes. This phenomenon was also seen in the United Kingdom's adoption of inflation targeting in October 1992 following exit from the European ERM, which arguably limited the inflationary pass-through of the one-time shock of devaluation. See Mishkin and Posen (1997) for a discussion of these events and this pattern of target adoption and use.
5. An authoritative survey on the subject is Friedman (1990).
6. Econometric observers have pointed out these patterns in various datasets. Neumann (1996) and Clarida and Gertler (1996) argue both points, that the Bundesbank has multiple goals and that it doesn't strictly target money. Von Hagen (1995) and Bernanke and Mihov (1996) focus on the latter point.
7. The resemblance between this approach and the one called for in the EC Council of Ministers' statement of October 1972 quoted in the previous section is almost perfect.
8. See e.g., "Recalculation of the production potential of the Federal Republic of Germany", BB October 1981.
9. "Methodological Notes on the Monetary Target Variable 'M3'", BB March 1988, pp 18-21.
10. Econometric evidence that the Bundesbank has displayed an asymmetry in reacting to target misses is offered in Clarida and Gertler (1996).
11. The Annual Report is described as "a detailed presentation of economic trends, including the most recent developments, together with comments on current monetary and general economic problems."
12. "While officially the question of the correct exchange rate was still under discussion, the German Chancellor announced his decision on the exchange rate without informing Bundesbank President Karl-Otto Pohl, although they had met only a few hours before." (Hefeker , p. 383) See Marsh (1992) for a longer historical account.
13. It should also be noted that the Bundesbank and the Swiss National Bank have differed widely in the design of their respective specific monetary targets - a range versus a point-target for percentage growth, calculated over a one-year versus a five-year time-horizon, defined on a broad versus a narrow aggregate - yet have achieved similar success in maintaining price stability (see Laubach and Posen (). This is a further indication that the souce of monetary targeting's advantages lies elsewhere than in measurably meeting some specific defintion of the target itself.
14. See Posen (1993, 1995).
15. Kenen (1995), pp. 191-193, discusses whether such accounting would provide sufficient accountability for the European Central Bank, and advocates further measures, such giving the European Parliament greater power over the ECB Statute and appointments.
16. Citations for unsigned central bank documents are given in the main text.
Bernanke, Ben and Ilian Mihov. (1996). "What Does the Bundesbank Target?" European Economic Review, forthcoming.
Bernanke, Ben and Frederic Mishkin. (1992). "Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries." In NBER Macroeconomics Annual 1992, eds. Olivier Blanchard and Stanley Fischer, pp. 183-228. Cambridge: MIT Press.
Clarida, Richard and Mark Gertler. (1996). "How the Bundesbank Conducts Monetary Policy." C.V. Starr Center for Applied Economics Economic Research Reports #96-14, April.
Deutsche Bundesbank. (1995). The monetary policy of the Bundesbank, Frankfurt, October.
Duisenberg, Wim. (1997). "Address on strategies for monetary policy in EMU." Board meeting of the Banking Federation of the European Union. Maastricht, March 21. Mimeo.
European Monetary Institute. (1997). The Single Monetary Policy in Stage Three: Specification of the operational framework, Frankfurt, January.
Friedman, Benjamin. (1995). "The Rise and Fall of Money Growth Targets as Guidelines for U.S. Monetary Policy." Mimeo, Bank of Japan Monetary Conference, October.
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Issing, Otmar. (1995a). "The Relationship Between the Constancy of Monetary Policy and the Stability of the Monetary System." Mimeo, Gerzensee Symposium of the Swiss National Bank.
Issing, Otmar. (1995b). "Monetary Policy in an Integrated World Economy," Mimeo, University of Kiel, June.
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König, Reiner and Caroline Willeke. (1996). "German Monetary Reunification," Central Banking, May, pp. 29-39.
Laubach, Thomas and Adam Posen. (1997). "Disciplined Discretion: Lessons from the German and Swiss Monetary Frameworks," Princeton Essays in International Finance, forthcoming.
Marsh, David. (1992). The Bundesbank. London: William Heinemann.
Mishkin, Frederic and Adam Posen. (1997). "Inflation Targeting: Lessons from Four Countries." Federal Reserve Bank of New York Economic Policy Review, August: 9-110.
Neumann, Manfred. (1996). "Monetary Targeting in Germany." Mimeo, Bank of Japan Monetary Conference.
Posen, Adam. (1993). "Why Central Bank Independence Does Not Cause Low Inflation: There is no Institutional Fix for Politics." In Finance and the International Economy: 7, ed. Richard O'Brien, pp. 40-65. Oxford: Oxford University Press.
Posen, Adam. (1995). "Declarations are not Enough: Financial Sector Sources of Central Bank Independence." In NBER Macroeconomics Annual 1995, ed. Ben S. Bernanke and Julio J. Rotemberg, pp. 253-274. Cambridge: MIT Press.
Schlesinger, Helmut. (1983). "The Setting of Monetary Objectives in Germany." In Central Bank Views of Monetary Targeting, ed. Paul Meek, pp. 6-17. New York: Federal Reserve Bank of New York.
Schmid, Peter. (1996). "Monetary Policy: Targets and Instruments." Central Banking, May, pp. 40-51.
Trehan, Bharat. (1988). "The Practice of Monetary Targeting: A Case Study of the West German Experience." Federal Reserve Bank of San Francisco Economic Review, Spring, 2:30-44.
Von Hagen, Jürgen. (1989). "Monetary Targeting with Exchange Rate Constraints: the Bundesbank in the 1980s." Federal Reserve Bank of St. Louis Review, September-October, 71: 53-69.
Von Hagen, Jürgen. (1995). "Inflation and Monetary Targeting in Germany." In Inflation Targets, eds. Leon Leiderman and Lars Svensson. London: CEPR.