monetary policy A Brittle Peace

The long-standing truce between the European Central Bank and Germany's Bundesbank looks strained as Mario Draghi insists lax ECB monetary policy has unanimous support, angering Bundesbank chief Jens Weidmann.
Quelle: Bloomberg
Mario Draghi and Jens Weidmann have conflicting views on ECB monetary policy.

Jens Weidmann, president of the Bundesbank, the German central bank, was to give a speech on "central banks at a crossroads" in Berlin on Thursday evening. Even the title, which said central banks can act as "the fire brigade or a fire accelerant,” hints at how divisive a subject this is.

The European Central Bank (ECB) policy of pumping billions of euros into the monetary system each month is anything but uncontroversial. Yet ECB president Mario Draghi’s comments at the bank’s most recent press conference suggested otherwise.

Following the last meeting of the ECB's governing council, the president said there was a consensus that the ECB had made the right decisions on monetary policy in December. Asked whether those who had not supported the decision in December had changed their minds, Mr. Draghi retorted that the ECB did not practice Maoist self-criticism. According to Handelsblatt sources, Mr. Draghi's remarks angered Bundesbank.

In the Bundesbank's view, there can be no talk of unanimity - even if Mr. Weidmann has not said this directly. According to reports, the Bundesbank representative made his criticism absolutely clear at the traditional dinner on the eve of the meeting, although Mr. Weidmann had no voting right at the actual meeting of the governing council on Thursday and was represented by Claudia Buch, vice president of Bundesbank. Both the ECB and Bundesbank declined to comment officially on events. The truce between the two institutions appears to be under threat.

In his latest speech to the economic council of Chancellor Angela Merkel's center-right CDU party, Mr. Weidmann made it clear he believes the ECB's policy is highly risky. "Central banks must not become a prisoner of the markets or of financial policy," he warned. Mr. Weidmann feels some monetary policy measures, particularly purchases of government bonds, harbor precisely this risk. That doesn’t exactly sound like unanimous backing for the ECB's strategy.

Central banks must not become a prisoner of the markets or of financial policy. Jens Weidmann, president of Deutsche Bundesbank

Despite their conflicting positions, the Bundesbank and the ECB have avoided attacking each other harshly in public since the height of the sovereign debt crisis. The two institutions try to keep their bones of contention out of the spotlight, to avoid further damage to the image of the euro.

According to a Eurobarometer survey from May 2016, 58 percent of Germans do not trust the ECB. The ECB has also lost a significant amount of support in other euro-zone countries. That makes it susceptible to attacks by politicians.

To avoid exacerbating this loss of confidence any further, members of the ECB's governing council believed that restraint was needed. While the council continues to argue fiercely over monetary policy internally, it had deliberately softened its public tone, partly to avoid a further boost to populists. However, this pact no longer seems to be holding up, in view of the growing tensions.

The ECB is currently keeping its base rates at a record low of 0.0 percent. It has also been buying up government bonds from euro-zone countries on a large scale since March 2015, to stimulate the economy and drive up inflation. At the critical meeting in December, several of the council's 25 members expressed concerns about the program. Some representatives were unable to support either of two proposed options for extending the controversial bond purchases, according to the minutes of the meeting. However, they are said to have welcomed a restriction on purchases and other aspects of the proposals.

According to the minutes, the two options discussed were a six-month extension of the bond-buying program leaving the monthly volume of €80 billion ($85.6 billion) unchanged, or a nine-month extension with a lower monthly volume of €60 billion. Prominent opponents of the bond purchases include Mr. Weidmann.

While the council continues to argue fiercely over monetary policy internally, it had deliberately softened its public tone, partly to avoid a further boost to populists.

At the meeting, the council members decided to extend their bond-buying program by nine months to the end of 2017, increasing the total volume of the program by over €0.5 trillion. The minutes of the latest ECB meeting have not yet been published.

The issue is also proving controversial within the ECB executive board, the six-member body responsible for implementing monetary policy for the euro zone. The other German representative at the ECB, executive board member Sabine Lautenschläger, also believes the central bank should start talking soon about phasing out its ultra-lax monetary policy.

"Things seem to be going up in the euro zone," Ms. Lautenschläger said at an event in Hamburg on Tuesday, explaining that all the requirements for stable inflation growth have been met. "I'm therefore optimistic we'll soon be able to look at the question of a phase-out." She added: "We need to be ready to act once we get to that stage." She did not say at what specific point the phase-out should begin.

Ms. Lautenschläger advocated a gradual reduction in expansionary measures, warning they should not be stopped abruptly. She said the ECB's lax monetary policy was strong medicine for a very sick patient. Over time, the intended positive effect of these measures would decline, while side effects and risks would increase. "That's why it's important to discontinue the medicine as early as possible, but not too early, as then we would risk a relapse."

She emphasized that she was optimistic and believed in the power of self-healing. "I don't think it's about waiting until the last doubts about a return to inflation have been eliminated." However, an overwhelming majority of decision-makers at the ECB see things differently and support Mr. Draghi's ultra-lax monetary policy.

27 p31 Inflation Germany and the Eurozone-01

Jan Mallien covers monetary policy for Handelsblatt out of Frankfurt. To contact the author: [email protected]