German Bundesbank Joins The ‘Fight Against Deflation’

Nonsense Proves Contagious

For a long time, the BuBa was held to be the main defender of anti-inflation orthodoxy in Europe. One must keep in mind here that Germany has had very bad experiences with inflation in the past. The WW1 wartime inflation was bad enough, but it was followed by the famous hyper-inflation episode of the Weimar Republic, which caused such large-scale misery that it has remained etched in the German psyche ever since. Partly this catastrophe occurred because the Reichsbank’s council had warmed to the ideas formulated in Georg Friedrich Knapp’s book ‘The State Theory of Money‘. Readers may be familiar with the modern-day version of Knapp’s chartalism, the so-called ‘modern monetary theory’ (MMT). In a nutshell, Knapp and the chartalists are certifiable monetary cranks (if you want to see more polite and extensive criticisms of chartalism, we recommend these articles by Bob Murphy and Robert Wenzel).

Anyway, the people that have imbibed the Bundesbank’s institutional tradition no doubt regard the Weimar hyper-inflation as a kind of ‘Ur-catastrophe’. It is e.g. widely held that the monetary breakdown of 1923 created the conditions that eventually brought Hitler to power. This may be debatable to some degree, as  the governments that were in charge between the inflationary conflagration and Hitler’s power grab made a great many mistakes as well. However, it is certainly true that widespread economic misery greatly helped the Nazis, not least because they were able to present themselves as the only force that could reliably keep Germany from succumbing to a communist revolution.

Current BuBa president Jens Weidmann has long been considered as standing between the more ambitious money printing plans of the ‘Southern Bloc’ on the ECB council, but apparently this is no longer the case. We previously argued that he may merely be playing along for tactical reasons, and it may well be that such considerations indeed play a role in the BuBa’s changed stance. However, it does appear that the nonsense about the alleged need to ‘combat deflation’ is contagious and that the BuBa has been infected as well.

The WSJ reports:

“Germany’s central bank is willing to back an array of stimulus measures by the European Central Bank next month if needed to fight unacceptably low inflation, underscoring the Bundesbank’s shift away from its reputation in recent years as the euro zone’s policy rebel.

The Bundesbank is open to supporting aggressive—and in some cases, for the ECB, unprecedented—steps including negative rates on bank deposits, long-term loans to banks at capped interest rates and purchases of packaged bank loans, a person familiar with the matter told The Wall Street Journal.

The euro fell sharply on the news of the Bundesbank’s stance, which lends support to mounting expectations in financial markets that the ECB will act decisively, and with unity, on interest-rate cuts and other measures when it next meets June 5.

Projections by ECB staff on inflation for 2016, which central-bank officials will have in hand when they meet, will be central to the Bundesbank’s decision on additional stimulus moves, the person said. But the German central bank’s readiness to act marks the clearest sign yet that the Bundesbank—in recent years defined by its conservative opposition to the ECB’s emergency measures to combat the euro-zone debt crisis—is fully engaged in fighting too-low inflation in the euro zone and open to using monetary-policy tools.

The Bundesbank’s position also signals a return to the fold for its president, Jens Weidmann, whose three-year tenure heading Germany’s revered central bank has often been characterized by his fierce opposition to the ECB’s main anticrisis policy: an open-ended bond-purchase plan launched in 2012 to stabilize bond yields of stressed euro-zone members. The conservative German central bank regards the program, though never tapped, as a dangerous mix of monetary and fiscal policies. Though the Bundesbank has been inching away from its opposition role and toward greater backing of ECB policies for nearly a year, the revelation of its low-inflation stance now serves a number of strategic issues for the central bank.

Tactically, a more flexible approach could benefit the Bundesbank by making its views more relevant in financial markets after finding itself largely isolated in its objection to previous efforts to ease market fears of a euro breakup. That, in turn, could strengthen its hand when it opposes such measures as large-scale asset purchases.

“They realize that they have a much stronger position if they come up with a list of proposals for what the ECB can do,” said Carsten Brzeski, economist at ING Bank. “It’s a more productive approach than the always-saying-no approach.”

The Bundesbank’s backing could provide critical support for ECB President Mario Draghi when the bank meets next month to weigh interest-rate cuts and other stimulus measures. Mr. Draghi put financial markets on notice last week that additional measures were possible in June amid weak annual inflation which, at 0.7% in the euro zone, is far below the ECB’s target of just under 2%. Germany’s inflation rate is slightly higher than the euro-zone average.

Central banks—particularly the inflation-wary Bundesbank—typically strive for low growth in prices, which keeps borrowing costs down and provides a stable backdrop for households and businesses to spend. But when inflation is too weak, debts become harder to service, and consumers may put off purchases in the hope that prices will fall. ECB officials have also made clear they are concerned about the high value of the euro, which weakens inflation.”