Inflation, Deflation And ECB Asymmetry

Jörg Bibow

It is quite interesting to see how popular myths can live on in the public’s mind and continue to cause harm and irritation even when the facts speak to totally different language. How can education fail so badly?

The particular example I have in mind here is Germans’ supposed exceptionalism in matters of inflation hyper-sensitivity. Whether or not Germans really are special in this regard, even internationally many observers seem to feel that Germans would be truly justified to be that way. Hence Germans are readily excused for doing stupid things because they seem to be justified that way. There is a highly relevant context to this today: the ECB’s asymmetry in mindset and approach.

I recently argued in a Letter to the Editors “Beware what you wish for when it comes to ECB measures”, published by The Financial Times on February 26 2014, that there was actually nothing really new about the ECB’s revealed asymmetry regarding inflation versus deflation risks. At issue is a genetic defect inherited from the Bundesbank. In fact, there can be absolutely no doubt anymore about the ECB being asymmetric in mindset and approach, and more and more observers have come to realize that in more recent times. But there is also a long track record of asymmetric “stability-oriented” monetary policy that includes and precedes the ECB’s own life.

My letter prompted a response from a Mr Han de Jong, the Chief Economist of ABN AMRO Bank in Amsterdam, arguing that there would be a solid basis in history for Americans to fear deflation over inflation while the opposite is true for Germans, pointing to the Great Depression as the biggest trauma in U.S. economic history of the last 100 years and contrasting it with Germany’s hyperinflation of 1922-23 (“Economic trauma scarred both the US and Europe”, Letters, March 3 2014).

This is surely right about America. While some US economists speak of the “Great Inflation” of the 1970s, which was followed by the Volcker shock and a double-dip recession in the early 1980s, this episode truly pales in comparison to the calamitous Great Depression experience of the 1930s. The memory of the Great Depression lives on in modern America. US policymakers are haunted by the ghosts of that historical episode. And that is a good thing!

When it comes to Germany, however, the story is less straight-forward than is popularly held. Economically, Germany’s experience of the Great Depression was almost as calamitous as America’s, the collapse in output and rise in unemployment were on a similar scale. Politically, events proved even more tragic for Germany. Germany did not have the great fortune to see the rise of a leader like FDR. For Germans the saddest chapter in their national history followed, ending in the demise of the Reich and its currency. In other words, Germany’s monetary history is rather symmetric, featuring both hyperinflation and catastrophic deflation.

But this is not the history one typically associates with Germany’s supposed inflation exceptionalism today. And this issue is also of some global significance. When Germany pushed for Europe’s embrace of unconditional austerity in the summer of 2010, which caused much controversy with the Americans and fractured the G20 at the time, finance minister Wolfgang Schäuble argued that Germany’s “aversion to deficits and inflationary fears, which have their roots in German history in the past century, may appear peculiar to our American friends, whose economic culture is, in part, shaped by deflationary episodes.” (“Maligned Germany is right to cut spending”, comment, June 24, 2010).

Notice here that somehow the experience of deflation was erased from collective memory and is no longer part of German economic culture, it appears. And somehow Germany’s distorted self-portrait even seems to find wide acceptance outside of Germany too. This is a puzzling social phenomenon. If Germans really have to go through a period of painful deflation to overcome their trauma of hyperinflation, as Mr de Jong suggests, this is only because they deny their own history. History does not offer any real excuse for the policy catastrophe unfolding today in Europe. Economic historians know that Germany’s Great Depression and deflation experience of the early 1930s was as real as Germany’s hyperinflation of the early 1920s.

Where does the popular mis-education come from then, one might wonder? Here is an illuminating example that we owe to former Bundesbank president Hans Tietmeyer:

The reasons for the success of German monetary policy in defending price stability are in part historical. The experience gained twice with hyperinflation in the first half of this century has helped to develop a special sensitivity to inflation and has caused the wider public to believe in the critical importance of monetary stability in Germany. For this reason, the strong position of the Bundesbank is widely accepted by the general public — questioning its independence even seems to be a national taboo. This social consensus has yielded strong support for the policy of the Bundesbank (Tietmeyer, H. 1991, “The Role of an Independent Central Bank in Europe.” In P. Downes and R. Vaez-Zadeh (Eds), The Evolving Role of Central Banks. Washington, DC: International Monetary Fund, p. 182).

So we learn here that, apparently, Germany even suffered two hyperinflations! Apparently the Weimar hyperinflation, i.e. the real one, led straight to Hitler, and the most memorable thing about that guy is that he was responsible for another German hyperinflation. Hence those poor German savers, in light of so much monetary suffering, really needed all the protection they could possibly get from that legendary independent central bank with its trademark asymmetry in mindset and approach. What a disgraceful rewriting of Germany’s monetary history that is!

But it was very effective and served its purpose, it seems.