The Bundesbank's communications strategy and policy conflicts with the federal government

Southern Economic Journal, Oct, 2005 by Pierre L. Siklos, Martin T. Bohl

1. Introduction

Even the most autonomous central banks cannot, at times, escape conflict with government. Conflicts arise either because the government disagrees with the current stance of monetary policy or with the central bank's outlook for future economic activity or because the monetary authority might be critical of government fiscal policy. Even the Bundesbank, a central bank that enjoys a considerable degree of independence, according to all of the most widely circulated rankings, has not escaped conflict during its illustrious life. (1) Quantifying the degree of conflict over policy issues is, however, problematic. The political economy literature suggests that electoral and/or partisan factors are significant sources of conflict [see, for example, Alesina, Cohen, and Roubini (1992), and sources therein], especially if the central bank sees the need to implement a monetary policy that is tighter than the government wishes or is not loose enough in a period of recession.

There exists a body of empirical work that documents significant political influence on Bundesbank behavior (references are provided below). Others argue that the Bundesbank was largely able to avoid responding to political pressure by shielding itself behind the notion of institutional independence. Some of the differences in views have to do with the fact that a central bank cannot be independent from government but is best thought of as an autonomous institution within government. Indeed, politicians who drafted the 1957 Bundesbank Law (Deutsche Bundesbank 1957) were keenly aware of the fact that conflict between the government and the central bank could not entirely be eliminated (Lohmann 1998). The difficulty of reaching a consensus about the significance of the impact of political pressure on the Bundesbank is partly a reflection of the variety of ways in which politicians can, directly or indirectly, attempt to influence central bank behavior.

In this paper we provide an estimate of the likelihood of conflict between the federal government and the Bundesbank that relies on the behavior of interest rate, exchange rate, and money supply behavior, political influences both at the federal (Bund) and at the federal states (Lander) level, as well as by incorporating a novel element into the analysis. These determinants of the likelihood of conflict have their origin in the institutional environment given by the laws governing the Bundesbank. More precisely, the advisory and public communications activities of the Bundesbank on monetary and economic policy issues, as well as the influence of federalism on monetary policy, are key components to understanding Bundesbank behavior.

Cukierman's (2000) theoretical model is used to motivate both the analysis and the empirical work. By specifying a variant of Rogoff's (1985) well-known conservative central banker model, Cukierman shows that the inflation bias is positively related to the likelihood that an economy is in a recession. The inflation bias is the principal source of conflict between the government and the central bank. Moreover, conflict seems more likely to take place when an economy is in a recession because the government, with one eye on the next election, may wish to confront the central bank on the stance of monetary policy currently being adopted. Similarly, a central bank may believe that its policy stance is appropriate and will eventually deliver the desired results, while the government may be less patient than the conservative central banker, prompting disagreement about the course of monetary policy.

Next, we argue that an institutional analysis of the Bundesbank, as well as a historical description of how it went about implementing monetary policy, suggests that public communication by Bundesbank officials is one of the determinants of the likelihood of government-central bank conflict. (2) The Bundesbank's role has changed substantially in light of the creation of the European Central Bank. As a result, the experience of arguably one of the most successful monetary institutions in the post-World War II era contains important historical lessons as they point to an important role for the communications strategy of a central bank in determining the degree of conflict with the political authorities. (3)

The rest of this paper is organized as follows. In the next section we discuss potential institutional sources of conflict between the Bundesbank and the federal government. Section 3 outlines the specification to be estimated and the data employed. Section 4 describes the empirical evidence, and section 5 concludes.

2. Sources of Conflict between the Bundesbank and the Federal Government

For the purposes of the present study three aspects of the laws governing the Bundesbank represent a potential source of conflict between the Bundesbank and the government in Germany. First, until the European Central Bank came into being, the federal government could, at most, request that the Bundesbank defer, but not overturn, a monetary policy decision it disagreed with. This power was never formally invoked. Thus, although the Bundesbank is "independent of instructions" from the federal government (Deutsche Bundesbank Act, section 12), it was expected to "support the general economic policy" of the government. No doubt such wording raised the probability of conflict between the federal government and the Central Bank Council, the body nominally responsible for implementing monetary policy, especially if the central bank takes seriously the task of commenting on fiscal policy matters. Nevertheless, the politicians who wrote the laws governing the Bundesbank understood the dangers inherent in establishing this kind of relationship between the Bundesbank and the political authorities, but in the end they felt that adequate institutional structures to entirely avoid such conflicts could not be properly designed (Kennedy 1991; Wahlig 1998).