Monetary Policy of Bundesbank

¶ … Deutsche Bundesbank in the period leading up to and following reunification. The paper explores the bank's monetary policies and considers their effectiveness in achieving the Bundesbank's stated goals of maintaining price stability in the German economy. The paper also discusses the role of credibility in advancing the Bundesbank's monetary policies.

Created by the Deutsche Bundesbank Act of July 26, 1957, the German central banks' mission was to achieve price stability. The Bundesbank steered the German economy through the expected collapse of the Bretton Woods system of fixed exchange rates, at its heyday from 1959 through 1968 (Garber, 1993). When Bretton Woods ended in March 1973, the transition to floating exchange rates gave the Bundesbank new scope for controlling domestic monetary conditions. This change opened up new opportunities for monetary policy, to which Bundesbank responded by pioneering the use of pre-announced annual growth targets for the money stock (Issing, 2005). During the course of its existence, the Bundesbank pursued monetary targeting policies which experts and analysts have sometimes assessed as controversial and in some cases counterproductive.

In the early 1970s the Bundesbank had to contend with inflation as the predominant problem for monetary policy makers. On October 31, 1972 the Council of Ministers of the European Community passed a resolution outlining the concept of monetary targeting based on a quantity equation. From that point on, the use of quantity theory became the basis for monetary target setting in Germany (Posen, 1997).

Germany began adopting monetary targets in December 1974 with the announcement of a growth target by the Bundesbank Central Bank Council. The Bundesbank had used the central bank money stock as its primary indicator of monetary developments since 1973, but this announcement marked the first time that it identified a specific target for the growth of central bank money. Dating from its adoption in 1975, the Bundesbank thereafter followed a strategy of publicly announcing numerical monetary targets and inflation goals underlying their computations (Posen, 1997).

The Bundesbank pursued its mandate of safeguarding the currency through periods of inflation, recession and oil crisis over the next decade and a half. It was not until the reunification process started to take shape that a series of unprecedented challenges developed. As part of the reunification, the process of monetary union required that a conversion rate be established between the West German Deutschmark and the East German Mark. Fundamental differences existed between the Bundesbank and the West German government on two key issues: the pace at which the monetary union should proceed and the conversion rate between currencies (Morys, 2003).