The struggle of German central banks to maintain price stability

It was only after the foundation of a nation state in 1871 that the basis was laid for a German central bank and a national currency. The era of the Mark came to an end in the hyperinflation of 1923. The succeeding Reichsmark had an even shorter life when it was replaced by the D-Mark after the 1948 currency reform. The Allies created a new central bank system for the, at the time, not yet constitutionally established Federal Republic of Germany. In 1957, the Bundesbank was established as the successor of the Bank deutscher Länder. In 1999, the D-Mark was replaced by the euro. Since then the Bundesbank has remained a central bank (within the European System of Central Banks), but without its own national currency. All these changes reflect the struggle of German central banks to deliver price stability. This chapter has shown that without the consent and cooperation of the government, even a notionally independent central bank cannot maintain stable prices. Central bank independence, important as it is, does not guarantee price stability if the political circumstances are not right. This became clear in 1922. Likewise, under a totalitarian regime, the concept of central bank independence becomes meaningless. Furthermore, the exchange rate regime and international cooperation may restrict the room for manoeuvre for the central bank to maintain price stability, as this chapter has shown. Interestingly, the independence of the German central bank, which was twice imposed by foreign governments, received broad (popular and political) support in Germany during the Second World War, no doubt due to the experience in one generation of two episodes which led to the total destruction of the German currency. But it is important to note that the Bundesbank did not operate in a political vacuum. As Goodman writes: ‘Its independence is not written in stone; its enabling law can be changed. To maintain that independence, the Bundesbank has been forced to take the views of West Germany’s major societal actors into account. In practice, the bank has always sought to build a coalition of supporting groups or, at a minimum, to avoid uniting too many powerful interests in opposition.’ It helped the Bundesbank to pursue policies which led to its high reputation for maintaining price stability. No wonder, therefore, that the ECB was largely modelled after the German central bank.