The Deutsche Bundesbank's Concept of Monetary Policy, With Particular Reference to its Choice of Intermediate Variables in the Period 1972-1979

The maintenance of price stability is the Bundesbank's ultimate objective. The memory of two hyperinflations within a 30-year period has made the fight against inflation of paramount social and political importance. In the Bank's view inflation engenders uncertainties which may jeopardise capital investment on which the competitiveness of German industry as well as full employment and economic growth depends. The Bundesbank pursues this goal by setting the marginal cost of central bank money required by the banks to finance their expansion. Thus, both the liquidity of the banking system and the cost of borrowing are controlled. This does not necessarily mean that the banks' loan rate of interest is the Bundesbank's Intermediate target. In fact, the Bank does not have one single intermediate target. Since the Bank's views of the monetary sector are manifested in the form of an interlocking system of financial variables, the selection of an appropriate intermediate target depends on the actual economic situation. In this context, the money stock supply (M3) is seen by the Bundesbank as functionally related to bank lending and the accumulation of long-term funds at the banks (monetary capital formation). An increase in interest rates would reduce bank lending, stimulate monetary capital formation and hence reduce the money stock supply (M3). In addition, it would check the utilisation of the money stock supply. This is seen as important because once money has entered the system it may generate unacceptable expenditure flows. To control the growth of the money stock supply, the Bundesbank relies on monetary capital formation, because small stocks of public debt rule out large-scale open market operations. In the Bank's view monetary policy should aim at keeping the banks' loan rate of interest as closely as possible to the natural rate. Lags in this Wicksellian transmission process may arise if the banks have ample margins between their loan and deposit rates when a restrictive monetary policy is implemented. As deposit rates adjust sooner than loan rates to a change in market rates, this also blunts the immediate impact of a policy change. The Bundesbank favours flexible rates of exchange in order to safeguard the financial system against inflows of foreign capital. It would welcome an appreciation of the D-Mark as a contribution to price stability, even though it could result in a loss of employment and exports as it stimulates German business to invest abroad. Furthermore, the Bank aims at constraining the monetary disturbances arising from public sector deficits and collective wage bargaining by means of its annual monetary growth target. This should serve as a signal to non-banks, which they are supposed to internalise in their decision-making. During the review period, the effectiveness of these safeguards was small as witnessed by inflows of foreign capital, large public sector deficits and excessive wage settlements. Moreover, the Bundesbank has been confronted with the development of parallel markets, in particular the Eurocurrency markets, in which borrowers can avoid the effects of its constraints.