Monetary Institutions: Maintaining Independence in Times of Fiscal Stress

Abstract

The most important task of a central bank is to preserve the value of a nation’s currency. However, during this century monetary institutions in Germany failed three times to guarantee price stability. Firstly, in 1923 hyperinflation arose as a consequence of the First World War. Secondly, after the Second World War Germany experienced high inflation, which was ended in 1948 by a successful currency reform in the Western occupation sectors and a fruitless one in the Soviet sector. Thirdly, the breakdown of the German Democratic Republic was accompanied by massive hidden inflation. The experiences of the first two inflation processes have led to an impressive macroeconomic success story: the Federal Republic of Germany went through a period of price stability lasting 50 years. Not only did the Deutschmark remain stable, but also Germany has experienced the lowest inflation rate (2.7 per cent) of all the OECD countries. Two institutions can be held responsible for this: the Bank Deutscher Lander (BdL), acting as a central bank between 1948 and 1957, and its immediate successor, the Deutsche Bundesbank (DBB). This chapter aims to analyse Germany’s monetary institutions and the institutional changes that occurred in their history. As we will see, the judicial rules of central banking have often been altered. The latest reform of the mid-1990s was the most dramatic one: the ‘taming’ of the German Bundesbank through the establishment of a European Central Bank. Furthermore, the political complexion of the central bank and several historical struggles for independence and price stability between 1948 and 1998 will be analysed, predominantly taking place in times of fiscal stress.