Options for Europe – Part 21

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[PRIOR MATERIAL HERE FOR CHAPTER 1]

Next stop – “L’Europe se fera par la monnaie ou ne se fera pas” – the European Monetary System (EMS)

[PRIOR MATERIAL HERE FOR THIS SECTION]
The Germans had started to embrace Keynesian policies in the mid-1960s after the nation was shocked by the recession in 1965 and 1966. In 1963, the government created the ‘Sachverständigenrat’ or Council of Economic Experts to advise it on macroeconomic policy setting. One of the early ‘Fünf Weisen’ (or ‘wise men’ as the Council members were known), Olaf Sievert (2003) reflecting back on the history of the Council, noted that in the post World War II period up to the mid-1960s, Germany had not followed the Keynesian path that defined macroeconomic policy making in most advanced western nations in this period. In the early period of the Council, German macroeconomic policy was dominated by the Austrian school liberalism of Ludwig Erhard, who was the CDU Chancellor between 1963 and 1966 and an early member of the conservative free-market Mount Pelerin Society. The recession changed things somewhat and under Willy Brandt, Germany increasingly embraced a Keynesian emphasis with strong economic performance in the late 1960s as a result. Sievert (2003: 35) noted that in the early 1970s, the Council was not free from Keynesian thought, but, equally, was not dominated by it (“Sie waren nicht frei davon, aber sie waren nicht voll davon”).

German monetary policy was caught between its prioritisation of domestic price stability and the obligations of the central bank under the Bretton Woods agreement. Hurt by the experience of the 1920s when the gold-backed Mark lost all value and by the further nominal wealth losses in 1948 when the Reichsmark was abandoned as part of the currency reforms, Germans place a high priority on price stability. One might say that this has become a cultural obsession and has influenced the design of their monetary institutions and the interaction between monetary policy (interest rate setting) and fiscal policy (spending and taxation) since. The new German Constitution in 1949 set in process the establishment of the Bundesbank, and the the resulting 1957 ‘Gesetz über die Deutsche Bundesbank’ (Bundesbank Act or Bundesbankgesetz) clearly stipulated the bank has “the primary objective of maintaining price stability” (Section 12) and that it is “independent of instructions from the Federal Cabinet [Government]” (Section 12).

The policy contradiction during this period was that the Bundesbank was required to defend the exchange rate (principally by expanding the money supply through the sale of Deutsche Marks to keep its value down) despite the basic charter of the Bank being to maintain price stability. Rising inflation as the currency strengthened in the latter part of the 1960s was a manifestation of this compromised position. Inflation further accelerated in 1973 as the oil price rises impacted – a common trend across the advanced world. The 1973 oil crisis was accompanied by significant real wage rises in Germany that were in excess of productivity growth and thus squeezed profits. Fiscal policy at the time was also expansionary, reflecting the Keynesian emphasis on strong domestic growth and high employment levels. The oil crisis soon changed all that.

When the Bretton Woods system collapsed and Germany floated against the US dollar in March 1973, the Bundesbank was freed to concentrate on domestic price stability commitments, although that freedom wasn’t absolute given the nation’s membership and obligations under the ‘snake’. Further, by the mid-1970s, the Council of Economic Experts morphed into a supply-side (neo-liberal) organisation after the first oil price hikes in 1973 (“Da stimmt doch etwas nicht. (Kommt der Sachverständigenrat wirklich vom Keynesianismus und findet dann zum angebotspolitischen Konzept?” Sievert, 2003: 34).

Helmut Schmidt succeeded Willy Brandt as German Chancellor on May 16, 1974 and while he maintained the ‘social-liberal coalition’ between his own SPD and the liberals of the Free Democratic Party (FDP), there were clear signals that the policy position was hardening to a more conservative ‘fight inflation first’ strategy. In Helmut Schmidt’s inaugural speech on May 17, 1974 to the Bundestag (Schmidt, 1974) he maintained the ‘Das Modell Deutschland’ (the German Model) as the way forward, a mix of hard-line attitudes to inflation with social policies to take the pressure of the collective bargaining process. In particular, he introduced a new emphasis on the need to redistribute national income back to profits to encourage investment, which in the long-term would ensure employment growth. He emphasisesd the limits on real wages growth and said that “with declining investments, neither the economy as a whole nor the individual worker would be served” (“Mit sinkenden Investitionen wäre weder der Volkswirtschaft insgesamt noch dem einzelnen Arbeitnehmer gedient”). He then delivered his famous call “Without investments there is no growth; without investments there is no job security, no higher wages and no social progress” (“Ohne Investitionen kein Wachstum; ohne Investitionen keine Arbeitsplatzsicherheit, keine höheren Löhne und auch kein sozialer Fortschritt”). Although this marked an end to the Keynesian embrace, he did stress that both private and public investment was necessary for future prosperity in marked contrast to the extreme Monetarist position that eschews significant public investment.

At the same time, the Bundesbank was starting to drink the Monetarist kool-aid, although the embrace didn’t last. Beyer et al. (2009: 18) argue that while the Bundesbank initially accepted the Monetarist views of Milton Friedman and others in 1974 and rejected fine-tuning the economy with interest rate adjustments in favour of formal targetting of the money supply, “the honeymoon with leading monetarists came soon to an end” when the Bank admitted that the ‘experiment’ failed and it could not control the money supply. It is a major doctrine of mainstream macroeconomics that the central bank controls inflation by controlling the money supply. Experience shows that the central bank is unable to do the latter and must use interest rate management if it desires to influence the state of the economy and have any impact on inflation. As we will argue in later chapters, the extent to which the central bank can influence price stability anyway is limited. It is important to note that the Bundesbank recognised that short-term growth imperatives were the responsibility of fiscal and industry policy administered by the government in conjunction with the roles played by industry and unions (the so-called ‘social partners’) in wage negotiations (see Beyer et al., 2009). Its role was to maintain long-term price stability.

While Raymond Barre was ridiculing the French trade unions, the SPD were busy implementing innovative policies such as ‘Mitbestimmung’ (participatory management or codetermination), which allowed trade unions to elect worker representatatives to sit on the management board of German companies. It complemented Germany’s long tradition of ‘Betriebsrat’ (Works Councils) which allowed workers to form bargaining units at the shop floor level to adjust the national collective bargains agreed between the peak employer and worker bodies to suit local circumstances. These initiatives were part of the anti-inflationary strategy. It was argued that if the workers had a stake in the enterprise management they would better appreciate the consequences of their bargaining demands.

Apart from dealing with the Bader-Meinhof gang, Schmidt’s other concerns were then focused on the increasing strength of the Deutsche Mark in the context of continued lack of confidence in the US dollar and the difficulties this posed for managing the shrinking ‘snake’ membership and maintaining the competitiveness of Germany’s export industries.

Some would say that Germany avoided most of the economic upheaval that beset the advanced world following the first oil crisis in 1974 as a result of Schmidt’s ‘abandonment’ of Keynesian policies. But the reality was that like in all Monetarist-tinged policy regimes, rising unemployment was the price that was paid. In 1974, before the policy position hardened, the unemployment rate in Germany was 2.8 per cent. By 1987 it was 10.5 per cent, having risen year-by-year over the Schmidt regime. Further, Keynesian ideas were not entirely cast aside. The government combined increased investment in worker education and training with public sector job creation strategies – the so-called Arbeitsbeschaffungsmaßnahmen (ABMs) – in response to rising unemployment. Further, unemployment benefits and other pensions were increased to help prevent the fall in aggregate demand. A Monetarist state would not have supported these demand-boosting initiatives.

The other legacy of the tight monetary policy approach adopted by the Bundesbank was that Germany came under increasing criticism, particularly from the US, which was continuing to suffer balance of payments difficulties and a weakening currency. It wanted Germany to ease interest rates and thus reduce the incentive for capital flows to move out of US dollars into Deutsche Marks.

Within this context, Schmidt increasingly started to look beyond domestic policy as a way forward for Germany’s major headache – the instability of its strong currency among weaker, neighbouring currencies. The Bundesbank was forced in late 1977 and early 1978 to engage in substantial intervention in the international currency markets (selling Deutsche Marks) to reduce upward pressure on the Mark. In its February 1978 Monthly Report (Deutsche Bundesbank, 1978: 6), they say that “The mood among German exporters was … depressed at the turn of 1977/78, primarily … because of the persistent rise in the Deutsche Mark, particularly against the US dollar”. The rising Deutsche Mark was making it very difficult to retain the ‘snake’ and this motivated Schmidt to pursue his ‘European’ initiative with a sympathetic (pro-European) Giscard d’Estaing.

Schmidt came to the view that the creation of an economic and monetary union would not only silence the critics of German monetary policy, but in helping to stabilise the German currency, would deliver benefits to German exporters.

[NOW I AM READY TO CONSIDER THE BREMEN ACCORD, COPENHAGEN IN 1978 AND THEN THE EMS in LATE 1978]

[END OF NEW MATERIAL TODAY – THE FOLLOWING TWO PARAGRAPHS ARE JUST SUSPENDED UNTIL I FILL IN THE DEVELOPMENTS THAT LED TO THEM]

On December 5, 1978, the European Council met in Brussels and agreed to set up the European Monetary System (EMS), which was to absorb what remained of the ‘snake’ and establish a European Currency Unit (ECU) (European Council, 1978). The EMS emerged out of a proposal put to the European Council meeting in Copenhagen in April 1978 by the French President Valery Giscard d’Estang and the German Chancellor Helmut Schmidt.

It won’t surprise the reader to learn that the system eventually found itself in crisis and instead of abandoning the almost impossible idea of tying these disparate European economies together into a functioning fixed-exchange rate currency zone, the European political leaders began the rocky road to Maastricht with a compromised EMS and the creation of the Delors Committee. But first, we have to tell the story.

[TO BE CONTINUED]

[WE ARE MOVING THEN TOWARDS THE DELORS REPORT IN THE LATE 1980s AND THE TREATY OF MAASTRICHT – THINGS WILL FLOW MORE QUICKLY AFTER THAT – I HOPE!]

Additional references

This list will be progressively compiled.

Beyer, A., Gaspar, V., Gerberding, C. and Issing, O. (2009) ‘Opting out of the Great Inflation, German Monetary Policy After The Breakdown of Bretton Woods’, ECB Working Paper Series No. 1020. http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1020.pdf

Deutsche Bundesbank (1978) Monthly Report of the Deutsche Bundesbank, February.

Gesetz über die Deutsche Bundesbank (Bundesbank Act), http://www.iuscomp.org/gla/statutes/BBankG.htm

Fabra, P. (1976) ‘Après la reprise et avant les élections I. – “Modell Deutschland”‘, Le Monde, July 6, 1976.

Llewellyn, J. (1983) ‘Resource Prices and Macroeconomic Policies: Lessons from Two Oil Price Shocks’, OECD Economics and Statistics Department Working Papers, Organisation for Economic Co-operation and Development.
http://www.oecd.org/eco/outlook/35552323.pdf

Schmidt, H. (1974) ‘Regierungserklärung von Bundeskanzler Helmut Schmidt vom 17. Mai 1974’.
http://www.hdg.de/lemo/html/dokumente/NeueHerausforderungen_redeRegierungserklaerungSchmidt1975/index.html

Siervert, O. (2003) ‘Vom Keynesianismus zu Angebotspolitik’, in SACHVERSTÄNDIGENRAT zur Begutachtung der gesamtwirtschaftlichen Entwicklung, Statistiches Bundesamt, Wiesbaden, 33-46.
http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/Sonstiges/Tagungsband.pdf