Hostname: page-component-586b7cd67f-t8hqh Total loading time: 0 Render date: 2024-11-20T08:52:38.879Z Has data issue: false hasContentIssue false
  • English
  • Français

Federalism and Central bank Independence: The Politics of German Monetary Policy, 1957–92

Published online by Cambridge University Press:  13 June 2011

Susanne Lohmann
Susanne Lohmann
Affiliation:
University of California
Get access

Abstract

Two channels of political control allow elected politicians to influence monetary policy. First, political threats to the status, structure, or very existence of the central bank may force central bankers to comply with politically motivated demands on monetary policy. Second, politicians may use their powers of appointment to ensure diat central bank appointees share their electoral and party-political goals. This paper derives the monetary policy outcomes obtained as a function of me degree of central bank independence (zero, partial, or full) and central bankers' types (partisans or technocrats).

Based on a case study of the 1957 and 1992 institutional changes to the German central banking system and a regression analysis covering the period in between, the author argues that the formal independence of the system is protected by its embeddedness in the institutions of German federalism and by the federalist components of its decentralized organizational structure. The behavioral independence of the German central bank fluctuates over time with the party control of federalist veto points. The Bundesbank is staffed with nonpartisan technocrats who are partially insulated from political pressures.

Type
Research Article
Information
World Politics , Volume 50 , Issue 3 , April 1998 , pp. 401 - 446
Copyright
Copyright © Trustees of Princeton University 1998

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

1 Kydland, Finn E. and Prescott, Edward C., “Rules Rather than Discretion: The Inconsistency of Optimal Plans,” Journal of Political Economy 85 (June 1977)Google Scholar; Barro, Robert J. and Gordon, David B., “Rules, Discretion and Reputation in a Model of Monetary Policy,” Journal of Monetary Economics 12 (July 1983)Google Scholar.

2 Rogoff, Kenneth, “The Optimal Degree of Commitment to an Intermediate Monetary Target,” Quarterly Journal of Economics 100 (November 1985CrossRefGoogle Scholar); Lohmann, Susanne, “Optimal Commitment in Monetary Policy: Credibility versus Flexibility,” American Economic Review 82 (March 1992Google Scholar).

3 Nordhaus, William D., “The Political Business Cycle,” Review of Economic Studies 42 (April 1975CrossRefGoogle Scholar).

4 Hibbs, Douglas, “Political Parties and Macroeconomic Policy,” American Political Science Review 71 (December 1977CrossRefGoogle Scholar); Alesina, Alberto, “Macroeconomic Policy in a Two-Party System as a Repeated Game,” Quarterly Journal of Economics 102 (August 1987CrossRefGoogle Scholar).

5 Empirical measures of legal versus behavioral central bank independence are discussed in Etjffinger, Sylvester and de Haan, Jakob, The Political Economy of Central-Bank Independence, Special Papers in International Economics, no. 19 (Princeton: Princeton University, May 1996Google Scholar).

6 Frey, Bruno S. and Schneider, Friedrich, “Central Bank Behavior: A Positive Empirical Analysis,” Journal of Monetary Economics 7 (May 1981Google Scholar); Soh, Byung Hee, “Political Business Cycles in Industrialized Democratic Countries,” Kyklos 39 (1986CrossRefGoogle Scholar); Neumann, Manfred J. M. and Lohmann, Susanne, “Political Business Cycles in Industrialized Democratic Countries: A Comment,” Kyklos 40 (1987CrossRefGoogle Scholar); Alesina, Alberto and Roubini, Nouriel, “Political Cycles in OECD Economies,” Review of Economic Studies 59 (October 1992CrossRefGoogle Scholar); Lang, Giinter and Welzel, Peter, “Budgetdefizite, Wahlzyklen und Geldpolitilc Empirische Ergebnisse fur die Bundesrepublik Deutschland, 1962–1989,” Jahrbucherfur National-okonomie undStatistik 210 (1992Google Scholar); Loynd, Brian and Alvarez, R. Michael, “Political Control of Central Banking: Is There a Role for Bank Autonomy?” (Manuscript, Duke University, 1992Google Scholar); Roland Vaubel, “Eine Public-Choice-Analyse der Deutschen Bundesbank und ihre Implikationen fur die Europaische Wahrungsunion,” in Dieter Duwendag and Jiirgen Siebke, eds., Europa vor dem Eintritt in die Wirtschafts- und Wahrungsunion (Europe before the entry into the economic and monetary union), Publications of the Verein fur Socialpolitik, new series no. 220 (Berlin: Duncker and Humbolt, 1993); Eschweiler, Bernhard and Bordo, Michael D., “Rules, Discretion, and Central Bank Independence: The German Experience, 1880–1989,” in Siklos, Pierre, ed., Varieties of Monetary Reforms: Lessons and Experiences on the Road to Monetary Union (Dordrecht: Kluwer, 1994Google Scholar); Johnson, David R. and Siklos, Pierre L., “Political Effects on Central Bank Behavior Some International Evidence,” in Siklos, ; Berger, Helge and Woitek, Ulrich, “Searching for Political Business Cycles in Germany,” Public Choice 91 (April 1997Google Scholar); idem, “How Opportunistic Are Partisan German Central Bankers? Evidence on the Vaubel Hypothesis,” EuropeanJournal of Political Economy 13 (1997Google Scholar).

7 Lohmann, Susanne, Brady, David, and Rivers, Douglas, “Party Identification, Retrospective Voting, and Moderating Elections in a Federal System: West Germany, 1961–1989,” Comparative Political Studies 30 (August 1997CrossRefGoogle Scholar).

8 Vaubel (fn. 6).

9 Balkhausen, Dieter, Gutes Geld und Schlecbte Politih Der Report fiber die Bundesbank (Good and bad politics: The report on the Bundesbank) (Diisseldorf: Econ, 1992Google Scholar), 139–40; see also Kennedy, Ellen, The Bundesbank: Germany's Central Bank in the International Monetary System (New York; Council on Foreign Relations Press, 1991Google Scholar), chap. 3.

10 “Auf Druckvon Oben,” Der Spiegel 39 (September 26, 1994), 105Google Scholar.

11 Schumpeter, , Capitalism, Socialism, and Democracy (New York: Harper, 1942Google Scholar), 293.

12 Kennedy (fn. 9), 8.

13 Marsh, David, Die Bundesbank: Geschafte mit der Macbt (The Bundesbank: Doing business with power) (Munich: Bertelsmann 1992), 33Google Scholar.

14 Beck, Nathaniel, “Presidential Influence on the Federal Reserve in the 1970s,” American Journalof Political Science 26 (August 1982Google Scholar); Woolley, John T., Monetary Politics: The Federal Reserve and the tics ofMonetary Policy (Cambridge: Cambridge University Press, 1984CrossRefGoogle Scholar); Grier, Kevin B., “Congressional Influence on Monetary Policy: An Empirical Test,” Journal of Monetary Economics 28 (October 1991CrossRefGoogle Scholar); Chappell, Henry W., Havrilesky, Thomas M., and McGregor, Rob Roy, “Partisan Monetary Policies: Presidential Influence through the Power of Appointment,” Quarterly Journal of Economics 108 (February 1993CrossRefGoogle Scholar); Havrilesky, Thomas, The Pressures on American Monetary Policy (Dordrecht: Kluwer, 1995CrossRefGoogle Scholar).

15 Neumann, , “Precommitment by Central Bank Independence,” Open Economies Review 2 (1991CrossRefGoogle Scholar).

16 Nordhaus (fn. 3) formulated his hypothesis assuming adaptive inflation expectations and myopic voters. The Nordhaus hypothesis with rational inflation expectations and rational retrospective voting is developed by Persson, Torsten and Tabellini, Guido, Macroeconomic Policy, Credibility and Politics (Chur, Switzerland: Harwood Academic Publishers, 1990Google Scholar); Lohmann, Susanne, “Rationalizing the Political Business Cycle: A Workhorse Model,” Economics and Politics 10 (March 1998CrossRefGoogle Scholar); idem, “Democracy, Inflation, and Growth: The Lucas Island Model Revisited” (Manuscript, UCLA, 1997Google Scholar); see also Rogoffand, Kenneth Sibert, Anne, “Elections and Macroeconomic Policy Cycles,” Review of Economic Studies 55 (January 1988Google Scholar); and Rogoff, Kenneth, “Equilibrium Political Budget Cycles,” American Economic Review 80 (March 1990Google Scholar). Alesina (fti. 4) adds rational expectations to the Hibbs (fh. 4) model; see also Chappell, Henry W. and Keech, William R., “Party Differences in Macroeconomic Policies and Outcomes,” American Economic Review, Papers and Proceedings 76 (May 1986Google Scholar).

17 The Vaubel hypothesis is formally developed in Lohmann, Susanne, “Institutional Checks and Balances and the Political Control of the Money Supply,” Oxford Economic Papers 50 (July 1998CrossRefGoogle Scholar).

18 The median voter hypothesis is formally developed in Lohmann, Susanne, “Partisan Control of the Money Supply and Decentralized Appointment Powers,” European Journal of Political Economy 13 (1997CrossRefGoogle Scholar).

19 For documentation of the primary and secondary sources I use, see Susanne Lohmann, “Designing a Central Bank in a Federal System: The Deutsche Bundesbank, 1957–1992,” in Siklos (fn. 6).

20 Goodman, John, “The Politics of Central Bank Independence,” Comparative Politics 23 (April 1991CrossRefGoogle Scholar), 337.

21 Ludwig Erhard in 1966, Kurt Georg Kiesinger in 1969, and Helmut Schmidt in 1982; see Marsh (fn. 13), 225.

22 Karl Otto Pohl in 1992; see Marsh (fn. 13), chap. 8.

23 Primary sources on the debate are collected in Bundesbank, Deutsche, Dreifiigjahre Deutsche Bun desbank: Die Entstebung des Bundesbankgesetzes vol 26. Juli 1957 (Thirty years Deutsche The genesis of the Bundesbank Law of July 26, 1957 (Frankfurt am Main: Deutsche Bundesbank, 1988Google Scholar).

24 Konneker, Wilhelm, “Vom Zentralbanksystem zur Deutschen Bundesbank,” Zeitscbriflfur das gesamte Kreditwesen 20 (1957), 796Google Scholar.

25 Kaltenthaler, Karl Christian, “The Bundesbank and German Federalism: The Politics of Institutional Change” (Manuscript, Washington University at St. Louis, 1992), 2–3Google Scholar.

26 Dickertmann, Dietrich, “Deutsche Bundesbank: Landeszentralbanken vor einer Strukturreform?” (Deutsche Bundesbank: Land central banks facing a structural reform?) (Manuscript, University of Trier, 1991Google Scholar).

27 Caesar, Rolf, DerHandlungsspielraum von Notenbanken (The discretionary leeway of central banks) (Baden-Baden: Nomos, 1981Google Scholar); Vaubel (fn. 6); Lohmann (fn. 19).

28 Maxfield, , “Financial Incentives and Central Bank Authority in Industrializing Nations,” World Politics 46 (July 1994CrossRefGoogle Scholar).

29 GNP is the standard measure of economic performance in German national income statistics; many other countries (including the United States) use gross domestic product instead. The exchange rate between the deutsche mark and the U.S. dollar is chosen because a significant amount of world trade is invoiced in dollars, and because the deutsche mark and the dollar are close substitutes in their role as international reserve currencies.

30 Here I Mo w Lang and Welzel (fn. 6).

31 I use 115 observations and not the 120 that might be expected for quarterly data covering the time period 1960–89. This is because of the loss of the first five observations that occurs when lagged fourth-quarter-to-fourth-quarter growth rates are formed.

32 Consider the model yt = α + βyt-1 + εt, where y is the dependent variable, α is a constant, β is the coefficient on the lagged dependent variable, and ε is a spherical disturbance. The bias of the OLS estimator of β, βOLS, is given by , where T is the number of observations. Note that the bias becomes small as T becomes large. (Moreover, the presence of additional regressors in the model decreases the bias.) One possible correction for the bias is to use the estimator see Peter Kennedy, A Guide to Econometrics, 2d ed. (Cambridge: MIT Press, 1985), 122. The regression results summarized in Tables 6 and 7 show that my qualitative conclusions are unaffected by the bias, noting that T equals 115.

33 Clarida, Richard and Gertler, Mark, “How the Bundesbank Conducts Monetary Policy,” NBER Working Paper no. 5581 (May 1996Google Scholar).

34 Ibid; and see also Ben Bernanke and Frederic Mishkin, “Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries,” in Blanchard, Olivier J. and Fischer, Stanley, eds., NBER Macroeconomics Annual 1992 (Cambridge: MIT Press, 1992Google Scholar); Neumann, Manfred J. M. and von Hagen, Jurgen, “Germany,” in Fratianni, Michelle U. and Salvatore, Dominick, eds., Monetary Policy in Developed Economies: Handbook of Comparative Economic Policies, vol. 3 Conn.: Greenwood Press, 1993Google Scholar).

35 This specification of the preelection dummy variable is standard in the empirical literature on political business cycles. Given that money affects employment and output with a lag of several quarters, this specification is not, strictly speaking, consistent with the idea that preelection monetary surges are meant to stimulate the economy and thereby increase the government's reelection prospects. I conjecture that increases in the money supply prior to elections reflect electorally motivated decreases in “visible” interest rates. This variant on the Nordhaus hypothesis is more plausible empirically, but it remains to be developed theoretically. For further discussion, see Lohmann (fh. 16,1997).

36 Berger and Woitek (fh. 6,1997) also test and reject the Vaubel hypothesis.

37 Frey and Schneider (fn. 6); see also Schultz, Kenneth A., “The Politics of the Political Business Cycle,” BritishJournal ofPolitical Science 25 (January 1995Google Scholar).

38 Alesina, Alberto and Rosenthal, Howard, Partisan Politics, Divided Government, and the Economy (New York; Cambridge University Press, 1995CrossRefGoogle Scholar); Alt, James E. and Lowry, Robert C., “Divided Government, Fiscal Institutions, and Budget Deficits: Evidence from the States,” American Political Science Review 88 (December 1994CrossRefGoogle Scholar); Poterba, James M., “State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics” Journal of PoliticalEconomy 102 (August 1994Google Scholar).

39 McCubbins, Mathew D., Noll, Roger G., and Weingast, Barry R., “Administrative Procedures as Instruments of Political Control,” Journal of Law, Economics, and Organization 3 (Fall 1987Google Scholar); Epstein, David and O'Halloran, Sharyn, Delegating Powers:A Transaction Cost Politics Approach to Policy Mak ing (New York: Cambridge University Press, 1998Google Scholar); Lohmann, Susanne and O'Halloran, Sharyn, “Divided Government and U.S. Trade Policy,” International Organization 49 (Autumn 1994Google Scholar).

40 Susanne Lohmann, “Why Do Central Banking Institutions Matter?” (Paper presented at the annual meeting of the American Political Science Association, San Francisco, September 1996).

41 Forder, James, “On the Assessment and Implementation of'Institutional' Remedies,” Oxford Economic Papers 48 (January 1996CrossRefGoogle Scholar), 39.

42 Cukierman, Alex, Central Rank Strategy, Credibility, and Independence: Theory andEvidence (Cambridge: MIT Press, 1992Google Scholar), 421.

43 Forder (fn. 41), 50.

44 McCallum, Bennett T., “Two Fallacies Concerning Central-Bank Independence,” American Economic Review Papers and Proceedings 85 (May 1995Google Scholar); Lohmann (fn. 40); idem, “Reputational versus In stitutional Solutions to the Time-Consistency Problem in Monetary Policy,” in Eijffinger, Sylvester C. W. and Huizinga, Harry, eds., Positive Political Economy: Theory and Evidence (New York: Cambridge University Press, 1997Google Scholar).

45 Posen, Adam, “Why Central Bank Independence Does Not Cause Low Inflation: There Is No Institutional Fix for Politics,” in O'Brien, Richard, ed., Finance and the International Economy, vol. 7 (Oxford: Oxford University Press, 1993Google Scholar); idem, “Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence,” in Bernanke, Ben and Rotemberg, Julio, eds., NBER Macroeconomics Annual 1995 (Cambridge: MIT Press, 1995Google Scholar).

46 Caesar (fh. 27).

47 Posen (fn. 45, 1993, 1995); see also Henning, C. Randall, Currencies and Politics in the United States, Germany, and Japan (Washington, D.C.: Institute for International Economics, 1994Google Scholar).

48 Lohmann (fn. 2).

49 Tsebelis, George, “Decision Making in Political Systems: Veto Players in Presidentialism, Parlia-mentarism, Multicameralism, and Multipartyism,” British Journal of Political Science 25 (July 1995CrossRefGoogle Scholar).

50 Banaian, , Laney, , and Willett, , “Central Bank Independence: An International Comparison,” in Toma, Eugenia Froedge and Toma, Mark, eds., Central Bankers, Bureaucratic Incentives, and Monetary Policy (Boston: Academic Publishers, 1986Google Scholar).

51 Peter Moser, “Checks and Balances and the Supply of Central Bank Independence,” European Economic Review (forthcoming).