May 9, 2012 8:04 pm

Bundesbank shows signs of yielding

A chink has appeared in the Bundesbank’s armour. Throughout the eurozone crisis, Germany’s famously conservative central bank has led demands for fiscal austerity, insisted that countries rectify their economic woes themselves through structural reforms – and denied Germany itself had to accept any compromises.

Its stance has been widely criticised by economists around the world, who fear German caution will simply send economies such as Spain’s deeper into recession and push the eurozone deeper into the mire.

On Wednesday, however, it became clear that under Jens Weidmann, its youthful president since last May, the Bundesbank’s stance may not be as hard-line as proponents suspect. In evidence to the Bundestag, or German parliament, the Bundesbank explicitly acknowledged that there would have to be some give on the German side.

If the crisis-hit periphery countries deflate their economies and slash wages’ costs to restore competitiveness, Germany, which went through its own restructuring process almost a decade ago, would have to accept a higher inflation rate than its eurozone rivals in coming years. “Germany could in the future have an inflation rate somewhat above the average within the European monetary union,” the Bundesbank wrote.

To non-Germans, the maths might seem obvious. But Germans, scared by memories of hyperinflation in the 1920s, are notoriously sensitive to the pace of price rises. The European Central Bank target is to keep annual eurozone inflation “below but close” to 2 per cent over the medium term. If Germany is to be above the eurozone average, that implies the country’s inflation rates might accelerate to 3 per cent, 4 per cent or even higher – substantially above those seen for most of the period since the euro was launched in 1999.

The International Monetary Fund approached the issue gingerly in its latest report on Germany, released on Tuesday. As the eurozone’s largest economy, the country could “play a pivotal role in addressing the challenges posed by the crisis”, the IMF concluded. As well as shaping the overall policy debate it argued that “disinflationary pressures incipient in the periphery economies, essential for their relative price realignment, could imply inflation in Germany that is somewhat higher than the euro area average”.

G4250X, inflation

The Bundesbank is not about to surrender its formidable reputation for fighting inflation, honed during previous international crises and especially after the inflationary 1970s. The Bundesbank would oppose any steps it saw as deliberately undermining Germany’s industrial competitiveness. It rejects the idea that Germany should embark on an expansionary fiscal policy in the hope of boosting demand elsewhere in the eurozone.

Moreover, writing in the Financial Times this week, Mr Weidmann warned that the ECB’s “very expansionary” monetary policy would be dealt with in Germany by “other, national instruments”. That could, for instance, involve tougher rules on mortgage lending by banks if recent rises in German house prices – encouraged by low interest rates – threatened to get out of hand. The aim would be ostensibly to ensure financial stability, but could be seen as addressing possible inflation risks.

But, despite its tough rhetoric, the Bundesbank has long accepted that the ECB’s responsibility is to set monetary policy for the entire 17-country eurozone. By definition, that means its interest rate decisions will not be ideal for any individual economy, even the bloc’s biggest. So far, Mr Weidmann has not disclosed how high German inflation could rise before the Bundesbank would demand an ECB policy response. But the central bank’s comments on Wednesday, hinted at a hitherto undisclosed degree of flexibility – which might bring a little relief to the rest of the eurozone.

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