Germany's Central Bank Pledges to Stay the Course
EUROPE is holding its breath for the Bundesbank to significantly reduce interest rates, but Germany's central bank is more likely to make a series of small adjustments downward than a quick, major relaxation.
Bundesbank deputy president Hans Tietmeyer says there has been "no fundamental change" in most of the factors that determine interest rate policy and so the bank is "staying the course."
Even so, the Bundesbank can still show "flexibility," Mr. Tietmeyer said in an interview with the Monitor. He cited the Jan. 7 decision to slightly lower short-term money market rates from 8.75 to 8.6 percent as an example. Both the slumping German economy and tension in the European Exchange Rate Mechanism influenced the decision, Tietmeyer said.
In setting interest rates, Tietmeyer emphasized that the bank is looking at tendencies and not for major, near-term corrections in key factors such as inflation and monetary growth. "I'm living in this world, and I'm not talking about bringing the inflation rate down tomorrow to 2 percent," which is the bank's goal for underlying inflation and about half of this year's expected rate.
Tietmeyer called relatively low producer prices "a small improving factor," but indicated that the bank's main concern regarding inflation is trend-setting wage talks to be held over the next few weeks. In comparison to last year, when unions won average wage increases of 5.6 percent in west Germany and 20 to 25 percent in east Germany, wage restraint this year looks more likely as unemployment tops 3 million.
The growth of the money supply, the most important factor in determining interest rates, is averaging around 9 percent (as measured by M-3) - high above growth targets.
Tietmeyer, however, said he does not "exclude" the possibility of meeting this year's M-3 growth target of 4.5 to 6.5 percent. This was adjusted from last year's growth target of 3.5 to 5.5 percent, which many economists criticized as too limited, given the substantial need for deutsche marks in east Germany as well as East Europe, where the mark is almost a second currency.
Naturally, the slack German economy can be expected to act as a brake on money supply, said Tietmeyer, who expressed hope that some factors behind last autumn's rapid growth in M-3 - such as a flow of investment money abroad in response to a new German tax on interest earned - will turn out to be short-lived phenomena. He was encouraged by M-3's slight tick downward in November.
The challenge for the Bundesbank, Tietmeyer admitted, is that it still doesn't know exactly how east Germany fits into the money supply picture. "The transformation [in east Germany] might create a lot of new transactions, and we don't know how that works precisely [or] whether our old experience is precisely appropriate for the new situation."
The Bundesbank has been battered by criticism from all sides: economists and industry at home, foreign governments, and the Organization for Economic Cooperation and Development.
Its critics argue that the central bank's tight monetary policy is hindering economic recovery in Europe, and now finally in Germany, which has belatedly entered recession. According to the German Institute for Economic Research in Berlin, the west German economy will shrink by 1 percent this year while east Germany's will grow 3.5 percent.
Tietmeyer admits that interest rates have been a factor in Germany's economic downturn. In recent months the Bundesbank has reduced only the rates of its open market transactions, while leaving the more closely watched Lombard rate (9.25 percent) and discount rate (8.25 percent) alone. "If we would reduce short-term rates too strongly, in too short a period, that could undermine our credibility," argues Tietmeyer. This could result, he fears, in higher inflation and consequently higher rates in capital m arkets crucial to long-term investment.
Some economists also blame the Bundesbank's stubbornly high interest rates for the September crisis in the European Exchange Rate Mechanism (ERM), when unbearable downward pressure on the British pound and Italian lira forced them out of the system. The ERM was supposed to ensure a stable, though still adjustable, exchange rate among European currencies and based on the deutsche mark.
Despite the fact that the French franc has been threatening to fall through its ERM floor too, Tietmeyer said he is "confident the system will survive." The economic fundamentals among the core group - which includes France - "are in order," he said.
Tietmeyer maintained that the ERM does not need to be fundamentally reformed, but that its rules must be applied. Countries such as Britain and Italy, he implied, should have sought a realignment of the ERM rather than tried to keep their currencies at artificially high rates.
The Bundesbank deputy president has cautionary words for his own government, especially regarding spending. His concern is not so much with this year's federal budget, but with an estimated 400 billion marks in east-German-related debt that will have to be serviced beginning in 1995. He's also concerned about the spending policy of the states and of the local authorities.
German Chancellor Helmut Kohl is seeking to spread the east German burden by forging a "solidarity pact" of cost restraint between labor, industry, and federal and state government.
"The appropriate solution is not to finance it out of the markets via higher deficits," Tietmeyer warned. "The best solution is to reduce other expenditures in the consumption area. The second-best solution would be to finance it out of a tax increase, but that always has a negative impact."
As a whole, the German economy is still in the midst of a "difficult transitionary period," said Tietmeyer. He said he hoped that growth in west Germany would resume during this year, but that high labor costs and inflexibility endanger competitiveness.