The search for autonomy: governments, central banks, and the formation of monetary preferences.

Author:Zimmermann, Hubert


  1. State Preferences in International Monetary Diplomacy (1)

    Introduced only in 1948, the German mark (DM) quickly acquired a reputation of stability and trustworthiness in international currency markets. Due to the strength of its currency, the Federal Republic of Germany (FRG) became a major player in international monetary policy from the mid-1950s onward. Its support was an essential factor in the preservation of the postwar international monetary order (the Bretton Woods system) which was characterized by fixed (but adjustable) exchange rates, the anchor role of the dollar, the dollar-gold exchange guarantee of the U.S., and the institutionalized transatlantic management of international monetary relations (Andrews 2003; Andrews, ed., 2008; Helleiner 1994). In the late 1960s, the system came under increasing strain and the U.S. called upon the major economic powers to support it by political and economic means. Shattered by a quick succession of speculative crises targeted at the DM-dollar exchange rate, German policy-makers saw themselves confronted with the increasing political constraints and economic costs of supporting the monetary system. With time, these costs seriously undermined their allegiance to the established framework of international monetary cooperation. As a result, alternative conceptions of monetary order emerged in Germany.

    The period of 1965-78 was characterized by uncertainty and conflicts about these alternatives which presented three different fundamental policy options to German monetary decision makers (Zimmermann 2001). The first option was the retention of (or return to) the transatlantic management of monetary relations. This required the close alignment of German monetary policy to trends in the dollar exchange rate in order to avoid excessive imbalances, the resulting, preferably institutionalized, cooperation with American (and British) monetary authorities, and the acceptance of the leading role of the dollar. The second was the option of "benign neglect" to external imbalances, which entailed flexible or floating exchange rates for the DM, liberated capital markets, and the orientation of monetary policy on purely domestic objectives. At the core of this option lay the idea of national autonomy, that is, the conduct of monetary policy with disregard to external considerations. The last option was a regionally managed monetary order in which monetary relations to the most important neighbors and trading partners were closely coordinated among the participating governments whereas the regional monetary zone as a whole appreciated (or depreciated) against the dollar. For German monetary policy, this option was in essence the idea of European monetary integration. Transatlantic cooperation, national autonomy, and European integration: those were the three conceptions of international monetary order which from about 1965 onward became the subject of intense debate in Germany. At the end of the 1970s, the FRG settled for option three, monetary integration in a European framework. Though this basic orientation was still contested and the creation of a working European monetary order was beset by numerous international and domestic conflicts, the result of which was by no means preordained, the European option prevailed at the end. The conceptual base of Germany's international monetary policy was transformed.

    Based on newly available classified material from German archives, this paper develops a framework for identifying the conditions leading to such fundamental policy changes in states and their reaction to external shocks (or monetary unions) in which monetary policy is co-decided by governments and a (more or less) independent central bank. It starts from the premise that the domestic constellation of monetary decision-making is a core factor explaining fundamental monetary orientations (2) of states (as opposed to explanations positing the explanation only on the level of the international monetary system). In addition, it specifies the circumstances under which the preferences of the government are more likely to prevail over those of an independent central bank.

    Fundamental changes in the orientations of states regarding their international monetary policies are rare. Usually, they are credited to external shocks, such as wars, major balance of payments crises, or strong pressure by dominant monetary powers. However, the extent and final result of such a reorientation is shaped by the interrelation of domestic and international factors. The international monetary policies of state actors cannot be understood in isolation from internal institutional dynamics, in particular the reaction of the major actors which formulate a country's external monetary policy, that is, the government and, in most industrialized countries, the central bank. Other domestic actors, of course, also exert influence, above all trade-dependent industries. This was the argument of Jeffry Frieden in a series of important articles (e.g. 1991, 2002). However, the institutional conditions for getting these societal interests represented remained underspecified in this argument (see also Kinderman 2008). Generally, the influence of societal groups in fundamental monetary questions is felt indirectly via the government which has the choice to represent or neglect these often conflicting preferences. (3) The dynamics of relations between the central bank and political authorities are therefore major determinants for the outcome of choices by states in monetary policy. It is in particular the attempt of governments and central banks to maximize autonomy in the pursuit of their respective preferences which conditions the responses of states to external monetary developments. (4) Based on this argument, this article claims broader relevance for situations in which governments and central banks are confronted with international monetary problems, in particular for the future monetary diplomacy of the Eurozone in which the institutional set-up closely follows the German example. However, the relevance of this argument does not stop here. 25 years ago, most central banks were dependent agents of governments. Now, most central banks enjoy a high degree of independence, usually combined with an over-riding mandate to pursue anti-inflationary policies (Bernhard 2002; Cukierman 2005). In this sense, the German case is instructive to illuminate the consequences of this relatively recent institutional constellation.

    For the monetary choices of the FRG during the period of system transformation since the early 1960s, the complex relationship of the German government to its central bank, the Bundesbank, is essential. A voluminous literature identifies a latent tension in the relationship between governments and central banks. Whereas governments, due to electoral concerns, accord primary importance to the establishment of economic conditions which are conducive to growth and full employment, central banks usually are concerned mainly with the stability of the currency (Caesar 1995). Thus, there is frequent conflict between governments which prefer expansionary economic policies to a more restrictive stance of the central bank. External constraints on the autonomy of governments and central banks are further factors leading to conflicts since they often have an asymmetrical impact on the actors. The preferences of both actors in the field of monetary diplomacy coincided for most of the time during the history of the FRG; however, during the monetary crises of the late 1960s and the early 1970s, conflicts emerged. At their core was the struggle for the power to define the fundamental direction of Germany's monetary policy.

    German postwar monetary policy was frequently shaped by these tensions. The outcome of conflicts between governments and central banks is usually decided by the extent of the central bank's autonomy in pursuing its objectives. Autonomy is defined here not only in the sense of institutional autonomy. This institutional autonomy or central bank independence is the subject of a well-established literature which has shown that the existence of an independent central bank is conducive to a stable currency. (5) It explains why most central banks are isolated to a certain extent from societal pressures. However, central banks are never completely autonomous. Governments have reserved themselves important leverage on monetary policy to ensure that their primary objective of re-election (or staying in power) is not jeopardized. This can be best achieved if a state's foreign and domestic monetary policy is geared towards solid economic growth, thus guaranteeing high employment and social stability. One core element in this respect is support for domestic industries which have to be shielded from the potentially disastrous impact of monetary disturbances.

    As defined by its institutional and legal framework, the Bundesbank was nominally independent in the pursuit of its primary objective: safeguarding the value of the currency. However, the government retained important resources, such as the power of appointment, the authority to determine the external value of the currency, and the possibility to exert public pressure on the Bundesbank (Lohmann 1998). Yet despite a corresponding body of laws as well as formal and informal rules, the conditions under which governments can decisively constrain the autonomy of institutionally independent central banks are hard to define very precisely (Bini-Smaghi 2008). In effect this depends much on what can be called real autonomy (in the sense of the political clout of actors to realize their preferences and to overcome possible opposition from other actors). Soft factors such as reputation and political context count a lot.

    I argue that geopolitical (6) arguments often give governments decisive leverage in conflicts with the central bank over...

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