Is short-term economic recovery worth sacrificing long-term economic stability? And is making a political point worth sacrificing foreign relations?
With her criticism on quantitative easing, Angela Merkel, the Germany chancellor, sparked a heated debate about monetary policy last week. And about whether it is appropriate for a head of state to criticise central banks.
Merkel attacked the European Central Bank (ECB) for its planned purchase of cover bonds and complained about the ultra-loose monetary policy being conducted by the Anglo-Saxon world. “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time,” she reportedly said after criticising European, British and American central bankers.
Ben Bernanke, the chariman of America’s Federal Reserve, promptly rejected Merkel’s criticism.
“I respectfully disagree with her views,” Bernanke reportedly said.
“The US and global economies, including Germany, have faced an extraordinary combination of a financial crisis … unlike any seen since the Great Depression, plus a very serious downturn. And in that context, I think strong action on both the fiscal and monetary sides is justified to try to avoid an even more severe outcome,” Bernanke said.
While Merkel’s comments went almost unheeded in Germany – Barack Obama’s visit to the Middle East and the twentieth anniversary of the Tiananmen Square crackdown dominated the headlines – they caused an outcry in Britain and America. She was widely accused of breaking an unwritten ban on German leaders commenting on monetary policy.
“Merkel and the German élite are divorced from the realities of the global economy, as well as flouting received economic wisdom from Keynes to Friedman,” wrote Charles Dumas, the director and head of world service at Lombard Street Research, in his Daily Note.
He warned that their budget policies would prolong dangerous global and European imbalances and it would bite the deficit British and American hand that feeds them. It could also damage free trade and German incomes, Dumas said.
German policies, behaviour, and Merkel’s outspoken undermining of fragile global securities markets, are a “menace” to the world economy, Dumas wrote. This applies in particular to Europe and especially to Germany.
His fellow-countryman, Ian Harnett, a joint managing director of Absolute Strategy Research, says he “can understand why Germany adopted that view”. The German government is clearly willing to sacrifice short-term economic recovery for long-term economic stability, he says. While the measures by the Fed and Bank of England are going to help economic activity in the short-term, they are introducing longer-term economic uncertainty and future inflation risk at the same time.
Harnett says Germany’s fear of inflation is “clearly understandable”, pointing to the hyperinflation episode in the Weimar republic. In December 1923, the exchange rate for Germany’s currency, then the papiermark, was 4.2 trillion marks to the dollar. The economically and politically fragile Weimar republic crumbled a few years later, clearing the way for Hitler’s National Socialism and the second world war.
In Berlin, the Deutsche Institut für Wirtschaftsforschung (DIW) says buying corporate and government bonds creates another “great inflation potential”. Merkel is right when she argues that it will cause problems if the ECB introduces similar measures, the DIW says.
Kerstin Bernoth, an economist at DIW, says it is not unusual for politicians try to influence the policies of central banks. President Nicholas Sarkozy of France, for example, asked the ECB two years ago to lower the interest rate.
“From time to time, politicians, whenever they feel their country is being disadvantaged, try to influence the decision of their central bank. This time, Merkel attacked all central banks.”
Michael Hüther, the director of the Institut der deutschen Wirtschaft (IDW) in Cologne, says: “Autonomy of central banks should have priority but one should keep a close eye on what the Fed is doing.”
“Extreme monetary policies”, such as quantitative easing, should always be introduced carefully, he says. “One should not forget that governments have little experience introducing such measures and they bear huge inflationary risks.”
“The ECB has often been criticised for running a monetary policy that is too weak and being implemented too slow,” Hüther says. “But it is a responsible approach.”
Harnett agrees: “In the longer-term, the eurozone bond market will be rewarded by the conservative approach.”
The ECB has adopted rather conservative approach to fight the economic crisis while America has doubled the amount of government debt over a very short time. “I doubt that America can reverse their course easily.”
Hüther says the approach is “dangerous” and could potentially lead to further political discussions. “One should also keep in mind that the crisis was partly caused by the American monetary policy,” he says.
Like Hüther, Harnett calls for a “balanced solution” where banks provide enough liquidity for financial markets without introducing too aggressive quantitative easing, as done in America and Britain.