Monetary policy reflects the strategic interaction of cabinet ministers, legislators, and central bankers in the policy process—strategic interaction that is conditioned by the formal and legal structure of the central bank. With an independent central bank, the cabinet has few direct controls over the central bank. The bank’s governing board typically includes individuals appointed by a variety of political actors. Additionally, the cabinet can sanction the central bank only with the cooperation of the legislature. These institutions give central bankers more room to maneuver in the policy process (McCubbins, Noll, and Weingast 1989). As long as the central bank has the support of actors in the legislature who can veto any potential punishment, it does not have to respond to the cabinet’s policy demands. Moreover, the bank can even challenge the cabinet’s policy choices. This allows other political actors—backbench legislators, coalition partners, upper house legislators, voters, and interest groups—to learn about monetary policy by the interaction between the cabinet and the central bank in the policy process.
An independent central bank therefore provides a check on the cabinet’s discretion. This function in turn provides an important incentive in the choice of central bank institutions. In situations where cabinet ministers, party politicians, and potential coalition partners have different incentives over monetary policy, an independent central bank can help prevent political conflicts that could hurt their ability to remain in office.
In this chapter, I examine the process of strategic interaction between the cabinet, legislators, and an independent central bank more fully. I first discuss the behavior to expect in the policy process. Second, I explore cases of strategic interaction between German politicians and the Bundesbank. In the conclusion, I show that politicians and central bankers from a number of countries recognize that an independent central bank can make cabinets more accountable for their policy behavior.
As noted in chapter 3, politicians can influence the behavior of an independent central bank through two mechanisms: appointments and threats to reduce the bank’s independent status (Lohmann 1998a). With an independent central bank, however, the cabinet does not possess sole control over either mechanism. The appointments procedures of an independent central bank typically limit the number of central government appointees to the bank’s governing board. Instead, other institutions possess the authority to determine parts of the bank’s board. In Germany, for example, Land governments appoint individuals to the Bundesbank’s governing council. In the United States, district bank presidents, selected by regional commercial banks and business interests, form a portion of the Federal Reserve’s main governing board.
Furthermore, the formal institutions of an independent central bank drastically curtail the cabinet’s authority to sanction the bank unilaterally. Typically, the bank can be punished only by a legislative act, requiring cooperation between the cabinet and the legislature. Threats to the bank’s institutional status therefore carry more weight when the cabinet and a legislative majority share similar policy demands. Because central bankers recognize that the cabinet and the legislature are more likely to cooperate to punish the bank under these conditions, it will be more responsive to political demands. If the cabinet and the legislature are divided, however, the threat to sanction the bank is less credible.
These institutional arrangements make an independent central bank accountable to multiple principals. Instead of being responsible only to the cabinet, an independent central bank is also answerable to other political actors, usually the legislature. The existence of multiple principals allows the bank to increase its room for discretionary behavior vis-à-vis the cabinet. Because both the legislature and the cabinet must cooperate to sanction the central bank, central bankers can play one principal off the other, protecting their institutional status by pleasing either the cabinet or the legislature (Morris 2000). In the U.S. context, for example, Havrilesky (1993) shows that the Federal Reserve responds to congressional threats by implementing the president’s policy demands. As long as the president is satisfied with the Federal Reserve’s policy behavior, any bill to change the bank’s institutional status will be vetoed.
The existence of multiple veto points in the legislative process can dilute even further the ability of politicians to threaten the central bank (Lohmann 1998a; Morris 2000). If the bank can satisfy one veto point, any attempt to sanction the bank will be blocked. For instance, central bankers may cultivate a legislative committee with gatekeeping power that can prevent a bill challenging the bank’s authority from reaching the legislative floor. In a parliamentary system with a multiparty government, the bank may attempt to appease only one party, as long as that party is pivotal to the coalition.
Central bankers are strategic actors. They carefully consider the consequences of their actions not just for markets but also for politics. They recognize the political environment and anticipate the reaction to their policy actions. They will seek to protect or even enhance their independent status. This strategic behavior is evident in two areas.
First, independent central bankers recognize that to maintain their policy discretion and even their independence, key political players—especially actors in charge of veto points—must understand the reasons behind the bank’s behavior. Consequently, central bankers will try to build support for their position, both appealing to society for approval and cultivating specific political actors (Berger 1997; Berger and de Haan 1999; Forder 1996; Goodhart 1994; Goodman 1992). In order to obtain this support, the central bank will selectively provide information and expertise about the available policy options and the consequences of those policy options.
Second, an independent central bank will not pick a fight with the cabinet that it cannot win. An independent central bank will openly criticize the government’s policy choices only when it appears that the government will be unable to craft a legislative majority to punish the bank. Likewise, an independent central bank will not challenge government policy, even if it disagrees with the cabinet’s proposal, when the government has solid legislative support.
Cabinet ministers are also strategic actors in the policy process, sensitive to the political context. Each actor anticipates the legislature’s policy preferences, calculating whether legislative support exists for either the cabinet’s or the central bank’s position. Because neither wants to suffer a legislative veto, each will defer to the other if it anticipates that it will lose a showdown. In equilibrium, therefore, both the government and an independent central bank will make the same policy recommendation to the legislature. As a consequence, the legislature will not often need to resolve policy disputes between the government and the bank.
The next section examines policy conflicts between the government and the central bank in Germany to illustrate the strategic interaction between politicians and independent central bankers.
The Bundesbank’s independence creates the potential for conflict over monetary policy with the government.1 Because the government possesses few controls over the central bank, Bundesbank officials can publicize any policy disputes. In many cases, the bank has “won” the policy dispute, either forcing the resignation of the defeated government minister or touching off controversy between the government and its legislative and coalition supporters (Berger 1997; Berger and de Haan 1999). In 1972, for example, Karl Schiller, the minister of economics, disagreed with the Bundesbank president, Karl Klasen, over the best response to changing international monetary conditions. Schiller favored floating the mark, while Klasen pressed for capital controls to stem the inflow of funds. Trusting the Bundesbank, the cabinet, with the legislature’s backing, voted to adopt the bank’s position, forcing Schiller to resign (Goodman 1992). In at least three cases, the Bundesbank’s policy actions have contributed to the resignation of the government or collapse of the governing coalition (Marsh 1992).2
The Bundesbank’s success in challenging the government’s policy choices reflects its institutional structure, its reputation, and its own strategic action. First, the appointments procedure to the Bundesbank ensures that the Central Bank Council includes representatives of both the Christian Democratic and Social Democratic parties, making the bank’s policy analysis more credible to legislators, coalition partners, members of the upper legislative chamber (the Bundesrat), and the public. Second, the Bundesbank’s unparalleled reputation for technical competence and inflation aversion gives the bank’s policy analyses added weight. Finally, the Bundesbank carefully developed political support both by cultivating specific interests in German society and by choosing its fights with the government carefully (Berger 1997; Berger and de Haan 1999; Goodman 1992). Because a simple legislative act could have overturned the Bundesbank’s independence, bank officials had to evaluate the balance of policy preferences in both houses of the legislature, gauging the level of its potential support, before criticizing the government. If the bank could not carry the day, especially if the government enjoyed majority support in the Bundesrat, the bank acquiesced to the government’s policy choices. If the government’s support in the legislature was divided or if the government did not enjoy majority support in the Bundesrat, however, the Bundesbank was in a better position to publicize its disputes with the government (Lohmann 1998a).
Several episodes of potential conflict between the government and the Bundesbank from 1970 to 1990 demonstrate the Bundesbank’s strategic behavior in the policy process. First, during the late 1970s and early 1980s, the Bundesbank used the political cover provided by divisions in the Social Democratic–led government coalition to criticize the government’s policy. Because the divisions between the left wing of the Social Democrats and the liberal Free Democrats prevented Chancellor Schmidt from threatening the Bundesbank, the bank could attack the government’s policy choices. The bank’s criticism exacerbated tensions in the governing coalition and helped precipitate its collapse.
Second, the Bundesbank had only muted responses to Germany’s European monetary commitments—participation in the EMS and in EMU. In both instances, one might have expected the Bundesbank to be critical of the government’s decisions. Indeed, the decisions to join both arrangements threatened domestic price stability and Germany’s policy autonomy. Yet in both situations, a majority of the legislature was likely to support the government’s plans to participate in both institutions. Consequently, the Bundesbank made only restrained public comments on these proposals.
Finally, the Bundesbank miscalculated its level of legislative support during Germany’s monetary unification. The Bundesbank opposed the generous exchange rate proffered to the East Germans by Chancellor Kohl. Kohl’s Christian Democrats, however, supported his move, recognizing the potential to capture new support from eastern voters. Consequently, the Bundesbank was largely excluded from any meaningful role in the process. Indeed, the Bundesbank president, Karl Otto Pohl, resigned because he recognized that he no longer commanded enough legislative support to serve as a counterweight to the government.
The following sections examine each of these episodes in more detail.
Beginning in 1969, the Social Democratic Party became the senior party in government for the first time in the postwar period, forming a coalition with the liberal Free Democratic Party. The two parties favored a more open foreign policy and more secular social policy than did the Christian Democrats. But on the economic-policy dimension, the two parties were unlikely coalition partners. The Social Democrats relied heavily on Germany’s trade unions for support. Their policy platform emphasized full employment and an expansionary welfare state. The Free Democrats, in contrast, appealed to middle-class and business interests and favored macroeconomic discipline.
Nonetheless, the coalition survived throughout the 1970s. Part of its longevity was due to the Bundesbank. The bank’s independence allowed it to criticize the policy actions of the Social Democratic–led government, alerting the Free Democrats if the Social Democratic Party attempted to cheat on the coalition agreement in the area of monetary policy. The credibility of the bank’s policy information, therefore allowed the Free Democrats to join the coalition despite their differences with the Social Democrats on economic policy.
Given the Social Democrats’ policy goals and constituents, one would have expected controversies with the Bundesbank over monetary policy. Although the government and the bank did disagree over policy a number of times during the 1970s, these conflicts came to a head only when changes in the composition of the governing coalition made it unlikely that the Bundesbank would lose a policy showdown.
The bank’s policy response after the first oil crisis created tension between the bank and the Social Democratic Party. Unlike other industrialized economies, Germany maintained a restrictive monetary policy following the oil-price shock, keeping inflation below the international average but contributing to sharp increases in unemployment. The restrictive monetary policies drew criticism from the trade unions, a key constituent of the Social Democrats. Herbert Ehrenberg, a Social Democratic Bundestag member, introduced a bill to change the Bundesbank’s official policy goals to include full employment and economic growth. The Social Democrats’ 1975 party program even included these proposals (Goodman 1992; Scharpf 1987).
Because of this threat to its independence, the bank was less willing to question the Social Democrats’ policies. Instead, the bank and the government agreed on a new role for monetary policy in 1974–75. Prior to wage negotiations, the bank would announce monetary targets for the upcoming year. These targets could then serve as a guideline for wage negotiations between unions and employers. Schmidt supported the monetary targets, hoping that they would help avoid conflict between the bank and the unions. Additionally, these targets were another way for the government to influence wage negotiations and as a result, maintain the competitiveness of German exports (Franzese 2000; Goodman 1992; Marsh 1992; Scharpf 1987).
The bank also became more accommodative toward the government’s economic policies. It eased monetary policy beginning in late 1974, lowering key interest rates. Additionally, it allowed monetary growth to overshoot its 1975 target (Goodman 1992; Scharpf 1987). In 1977, a relatively loose monetary policy complemented the government’s expansionary fiscal policy, a policy that increased spending on public investment and provided tax relief for business and families (Scharpf 1987).
The international economic situation, however, continued to deteriorate. In the United States, President Jimmy Carter entered office in 1977 and initiated a series of tax cuts to fuel economic expansion. The Carter administration pressured Germany and Japan to follow suit. When they did not, the U.S. dollar began to depreciate rapidly against the mark and the yen (Henning 1994). Nevertheless, Germany’s current account remained in surplus, drawing even more criticism from the United States.
At the 1978 Bonn Summit of the Group of Seven (G-7) countries, Chancellor Schmidt relented to U.S. pressure, agreeing to an immediate increase in aggregate demand of at least 1 percent of gross domestic product (GDP). To ensure the Bundesbank’s cooperation, Schmidt carefully gathered support for the program, particularly from the Free Democrats, prior to presenting it to the Bundesbank. Disagreeing with Schmidt’s policies would have left the Bundesbank isolated at home and abroad. Consequently, the Bundesbank consented to an increase in the public-sector borrowing requirement, implying it would not raise interest rates to counter higher government spending.
Only a few months later, however, the second oil crisis hit, nearly tripling oil prices between 1978 and 1980. Unlike the first oil crisis, however, the German economy was in a vulnerable position. Other countries decided to deflate their economies in response to the crisis. Consequently, the market for German exports, the traditional engine of economic growth, dried up. At the same time, the German economy was expanding, spurred by higher government spending. The domestic expansion fueled a greater demand for imports. As a result, the current account quickly swung into deficit and inflationary pressures began to build. The D-mark also began to depreciate against the U.S. dollar.
To counter these pressures, the Bundesbank began a gradual tightening of monetary policy in January 1979. The government, however, thought a more restrictive monetary policy would jeopardize the economic recovery—and possibly, its fortunes in the upcoming elections—and argued against interest-rate increases. The Bundesbank ignored the government and increased the Lombard rate by a half point. In response, Social Democratic government ministers openly criticized the bank’s policy actions, although Schmidt himself was careful to avoid public debate. Major newspapers and the Free Democratic economics minister, Count Graf Lambsdorff, rallied to the bank’s defense, insulating the Bundesbank from the government’s criticisms (Goodman 1992). Consequently, the discount rate increased steadily from early 1979, from a low of 3 percent to a high of 7.5 percent in the summer of 1980 (Henning 1994; Scharpf 1987).
The 1980 elections increased the strength of both the Free Democrats and the left wing of the Social Democrats, accentuating conflicts over the best response to the growing economic crisis (Goodman 1992; Scharpf 1987). Hoping to appeal to business, the Free Democrats argued for tax cuts as a way to stimulate growth and investment. The left wing of the Social Democrats and the trade unions pushed for increased spending to reward the unions’ wage moderation in the late 1970s and to combat rising unemployment. Caught in between, Social Democratic cabinet ministers countered with an economically responsible but politically infeasible tax on oil imports to lower the budget deficit (Goodman 1992).
Faced with a dwindling supply of foreign reserves in early 1981, the Bundesbank decided to tighten monetary policy dramatically to stabilize confidence in the mark. The bank suspended the regular Lombard facility, replacing it with an unprecedented special Lombard rate at 12 percent. Money market interest rates soared to over 30 percent. These actions helped to maintain the D-mark’s value against the dollar, but they also worsened the recession.
Although Schmidt recognized that U.S. monetary policy constrained German policy options, he pressured the Bundesbank to cut interest rates. Bundesbank officials responded unsympathetically, suggesting that the fiscal crisis needed to be solved before interest-rate reductions could occur. The Bundesbank’s policy actions, however, exacerbated tensions within the ruling coalition. Although lower U.S. interest rates brought some relief in mid-1982, the conflict between the Social Democrats and the Free Democrats had become irreconcilable. The Free Democrats left the coalition and formed a new government with the Christian Democrats. The new government immediately undertook a program of deficit reduction. In response, the Bundesbank quickly lowered interest rates (Goodman 1992).
The bank’s ability to challenge the cabinet reflected the policy divisions within the Social Democrat–Free Democrat coalition. Because the coalition’s priorities were divided between the probusiness Free Democrats, the pro-worker left wing of the Social Democrats, and moderates in the cabinet, it was unlikely that the governing parties would cooperate to punish the Bundesbank. As a consequence, the bank could act against the government’s demands, secure that it had a legislative majority (i.e., the Christian Democrats and the Free Democrats) that generally supported the bank’s policy stance and would not overturn its independence.
In contrast to the conflict between the Bundesbank and the Schmidt government, the Bundesbank’s criticisms of Germany’s commitment to European-level monetary institutions have been muted, even though these commitments threatened both domestic price stability and the Bundesbank’s own policy authority. Bundesbank attacks on European commitments were not likely to find support among Germany’s politicians. Not only does Germany’s role in Europe generally enjoy cross-partisan support, but such criticism might also be viewed as a challenge to the government’s authority to make foreign policy.
The Bundesbank was skeptical of plans for the EMS, fearing that participation in the system could compromise domestic price stability (Goodman 1992; Heisenberg 1999; Henning 1994; Kennedy 1991; Marsh 1992). Bank officials also realized that a formal exchange-rate commitment would limit their own policy discretion and make monetary policy more susceptible to political influence through the determination of currency parities. Bank officials were also upset that they had been excluded from the initial negotiations over the system. Indeed, Schmidt and his French counterpart, President Valery Giscard d’Estaing, had specifically excluded all other actors from their negotiations to limit opposition to the proposal.
Schmidt recognized the Bundesbank’s concerns—and its ability to foment opposition to his plans. He traveled to Frankfurt to persuade the Bundesbank Council to support the initiative. His argument in favor of the EMS went beyond the technical merits of the plan, touching on Germany’s role in Europe and the historical legacy of World War II (Henning 1994; Kennedy 1991; Marsh 1992). Schmidt suggests that he threatened in a “cautious” and “diplomatic” manner to change the Bundesbank law, although no one corroborates his claim (Marsh 1992). Despite their reservations, Bundesbank officials did not criticize the plan publicly, although they did press the government to make some technical modifications to the agreement concerning the requirements for intervention. Additionally, government officials pledged that they would leave the system if participation threatened domestic price stability.
The Bundesbank’s response to EMU was also subdued, considering that the plans for EMU would effectively destroy the Bundesbank’s authority. In the late 1980s, the Bundesbank recognized that monetary union would receive serious consideration on the European agenda. Indeed, German foreign minister Hans-Dietrich Genscher had stirred renewed interest in monetary union in 1987. The fall of Communism and German unification also provided fresh impetus to the idea of a single currency. Within Germany, politicians across the political spectrum recognized the importance of reaffirming Germany’s commitment to Europe. Consequently, the Bundesbank accepted its inability to stop the process.
Instead of opposing the concept outright, the Bundesbank decided to influence the negotiations, putting forward conditions it would find acceptable (Heisenberg 1999; Henning 1994; Marsh 1992). The bank argued that the final transition to a single currency should be determined by convergence of member-state economies, rather than by fixed deadlines. Additionally, the bank called for a fully independent European Central Bank, dedicated to the goal of price stability. Finally, it maintained that monetary union could succeed only with greater political integration, especially in disputes over the allocation of fiscal resources. These requirements represented a “no-lose” gamble for Germany and the Bundesbank. On the one hand, the conditions would create a monetary union dedicated to price stability. On the other hand, the conditions were so stringent that it was possible that other European member states would not accept them or fail to comply with the convergence criteria, leaving the status quo in place.
The Maastricht Treaty requirements for EMU look similar to the Bundesbank’s demands, although the final agreement contained some differences, including deadlines for the transition to the final stage and political control over European participation in exchange-rate agreements. In general, the Bundesbank has faithfully supported the agreement, recognizing the treaty’s cross-partisan support at the elite level and foreign-policy implications. At times, Bundesbank officials complained about the terms of the treaty, but these complaints were restrained (March 1992). Indeed, given the German public’s potential hostility to the loss of the D-mark, the Bundesbank behaved responsibly by refusing to stir up anti-EMU sentiment.
German monetary unification demonstrates that even independent central bankers must gauge the policy preferences of the legislative majority before challenging the government’s policy. During monetary unification, the Bundesbank failed to realize the popularity of Chancellor Helmut Kohl’s plans among his legislative followers. Consequently, it lost a policy showdown with the government (Henning 1994; Kaltenthaler 1996; Lohmann 1994; Marsh 1992).
After the fall of the Berlin Wall in November 1989, the Bundesbank approached the prospect of monetary unification with a cautious pragmatism, guided by the desire to maintain domestic price stability in the West. Bundesbank president Karl Otto Pohl recognized that monetary unification would require drastic adjustments to the East German economy to be successful. As late as January 1990, Bundesbank representatives characterized a rapid monetary unification as “fantastic” and “very unrealistic” (Marsh 1992, 208). Nevertheless, in early February 1990, Pohl traveled to Berlin to meet with Horst Kaminsky, the head of the Staatsbank—the East German central bank. At their press conference, Pohi suggested that talk of monetary union was “premature.” In private meetings with East German officials, the Bundesbank leadership expressed strong opposition to the possibility of a one-to-one exchange of East German marks (Marsh 1992).
Chancellor Kohl, however, had different incentives over monetary unification. He understood that the unification of Germany represented not only an historic opportunity but also a political one. Just as Pohl was traveling to Berlin, Kohl was meeting with his advisors concerning monetary unification. Although most counseled a gradual approach, leaders of the Christian Democratic Party in East Germany persuaded Kohl that a quick move to monetary unification was the only way to stem the tide of westward migration and restore hope to the East. Moreover, by moving quickly to integrate the East, Kohl could ensure that his fellow Christian Democrats would benefit in the upcoming East German elections scheduled for March. The following day, shortly after Pohl’s Berlin press conference, Kohl went on television to propose a speedy monetary union.
Pohl and the Bundesbank were caught off guard. Pohl had talked briefly with Kohl and government ministers prior to his trip to Berlin, but they had given no indication of the potential for such an announcement. A few days later, Pohl organized a highly unusual press conference to discuss the difficulties associated with the government’s proposal, including the need for structural adjustment in the East and higher taxes in the West. He reacted to the surprise of Kohl’s announcements, stating “I always advise the government to consult the Bundesbank first” (Marsh 1992,214).
Pohl’s statements worsened the relationship between Bonn and the Bundesbank. Consequently, the Bundesbank found itself increasingly excluded from the policy choices surrounding unification. As the negotiations for monetary unification commenced, the government requested the Bundesbank to recommend a conversion rate. After internal debate, the Bundesbank settled on a two-to-one ratio—a rate they believed economically and politically feasible. The government, however, overrruled the bank’s proposal, instead offering generous terms for monetary conversion, including a one-to-one exchange for smaller savings deposits. In May, without consulting the Bundesbank, the government created the German Unity Fund to transfer funds to the East (Marsh 1992).
Excluding the Bundesbank from the policy process exacerbated tensions between the government and the bank. In May 1990, just as the Monetary Unification Treaty was signed, two Land Central Bank presidents made public statements challenging the government’s actions. One complained publicly, “The government has to stop acting as if the autonomy of the Bundesbank has been put aside for the process of reunification” (Marsh 1992, 218). The other warned of the inflationary pressures of the government’s plans. Perhaps sensing that the Bundesbank had already lost the fight with the government and that further criticism could result in a change of the bank’s independent status, Pohl ordered his fellow council members to soften their public comments (Marsh 1992).
The Bundesbank’s predictions for the government’s plan—unemployment and loss of competitiveness in the East and deficits and potential inflation in the West—turned out to be largely correct. The Bundesbank’s alarms, however, fell on deaf ears. The popularity of monetary unification among Kohl’s legislative supporters allowed him to move forward with the generous plan, despite the Bundesbank’s position. The Christian Democrats stood to make significant electoral gains by positioning themselves as the party of German unity. Indeed, they had the most votes both in the March 1990 elections in East Germany and in the December 1990 national elections—the first after unification. Unlike previous policy disputes between the bank and the government, the legislature had more to gain from Kohl’s plan than from the Bundesbank’s caution. Instead of the government losing the policy showdown, the Bundesbank was forced to back down.
Pohl resigned the following year in May 1991. The resignation was triggered in part by some of Pohl’s public statements on EMU. He argued that monetary union without convergence would be a “disaster,” just as it had been for East Germany. This comment touched off a small run on the D-mark and drew criticism from Kohl (Marsh 1992). More importantly, Pohl stepped down because he had become increasingly marginalized in the policy process following the Bundesbank’s political miscalculation over monetary unification. In August 1991, he complained, “I have been talking myself blue in the face for eighteen months. . . . Everything I said was ignored. . . . If I had the feeling I could have prevented it [the deterioration of the budgetary position], I would not have quit” (Marsh 1992, 41).
The Bundesbank’s independence creates potential problems for German governments. The history of the bank illustrates that its policy statements carry serious political consequences, potentially causing the government to lose support or preventing the government from satisfying some of its constituents. One might expect that German politicians would attempt to rein in the independent bank by altering its institutional structure. Why do German politicians tolerate the independence of the Bundesbank? What explains their commitment to this institution, despite the bank’s ability to challenge the government’s policy?
Part of the answer comes from the Bundesbank’s strategic action in the policy process. Helmut Schlesinger, Bundesbank president in the 1990s, recognized the bank’s situation, stating, “Our independence depends on our ability not to overstep our limits” (Marsh 1992, 256). Independent central bankers must recognize and respond to the policy incentives of the government and its legislative and coalition principals. Before criticizing the government, independent central bankers must gauge whether backbench legislators and coalition partners will follow the bank’s advice and reject the government’s policies or whether the government’s principals stand to gain more from accepting the government’s policy choice. Too much or too little criticism can threaten the bank’s independence. For most of its existence, the Bundesbank has successfully played this political balancing game (Berger 1997). Indeed, one European central banker noted, “It is ironic that the Bundesbank, the world’s most politically independent bank, is also the world’s most politically active central bank.”3
The commitment of Germany’s, politicians to an independent Bundesbank also reflects the political benefits of an independent central bank. The Bundesbank has a political function—to provide information about the government’s monetary policy choices and the consequences of those choices. The Bundesbank’s institutional structure and reputation endow its policy evaluations with credibility in the eyes of backbench legislators, coalition partners, and ultimately, voters. The credibility of that information helps politicians in the governing parties—politicians who are likely to have different incentives over monetary policy and different information sets—trust one another. Consequently, the Bundesbank can help prevent monetary policy conflicts from happening and help political parties remain in office.
Indeed, officials at the Bundesbank and the European Commission pointed to the informativeness of the Bundesbank to justify the existence of independent central banks in democratic societies. They argued that the Bundesbank had the responsibility to comment on the direction and consequences of government economic policies. Together with private economic institutes, the Bundesbank’s opinions and forecasts provided counterweights to the government’s “politically watered-down” statements on economic policy.
Survey evidence indicates that the legislators value the Bundesbank’s policy analysis more than the government’s policy pronouncements or other sources of economic information. In anticipation of an April 1998 vote on whether to participate in the single currency, Heisenberg (1998) polled Bundestag members about their attitudes toward EMU. She found that Bundestag members relied on the Bundesbank for information about the euro. Over 79 percent indicated that the Bundesbank’s opinion on participation in EMU was an “important” factor in their decision—a higher percentage than any other source,4 including recommendations by the European Commission, a vote of the European Council, party instructions, or public opinion surveys. Interestingly, this result held across the four major parties. Even Social Democratic and Green legislators were very likely to trust the Bundesbank’s policy recommendation. The Bundesbank’s credibility crosses party lines.
Evidence from a number of other countries indicates that central bankers and politicians recognize the political importance of an independent central bank’s credibility in the policy process.5 Parliamentary debates in New Zealand over the 1989 Reserve Bank Bill echoed this informational justification for reforming their central bank. Proponents argued that an independent central bank would actually increase the transparency of the policy process and as a result increase government accountability. While the government would determine the ultimate objectives of monetary policy, the central bank would report to the parliament about the economic consequences of the government’s policy choices and the perseverance with which the government pursued those objectives. Consequently, the bill would improve the cabinet’s accountability: “The Bill will help to eliminate . . . uncertainty by enhancing the accountability of both the Reserve Bank and politicians. It will force Ministers of Finance to be open about adopting alternative policies and their inflationary effects, and will make the Reserve Bank more independent by placing the implementation of monetary policy outside day to day ministerial manipulation” (New Zealand Parliamentary Debates 1989, 10425). Another proponent argued: “[W]hile it [the bill] provides a means for the Government to change the objective of monetary policy, that will have to be done in a way that is transparent. This should enhance public scrutiny of Government actions” (New Zealand Parliamentary Debates 1989, 14501). Some legislators even claimed that the bill did not do enough to encourage the governor to issue evaluations of government policy: “[I]t is essential that . . . the Governor of the Reserve Bank have the capacity to comment on the complete spectrum of economic management,” rather than just monetary policy (New Zealand Parliamentary Debates 1989, 14698).
In the United States, Congress requires the Federal Reserve chairman to report semiannually on monetary policy. These appearances and the Federal Reserve’s regular economic reports give legislators a better understanding of both the central bank’s specific activities and the president’s monetary policy choices. Additionally, the chairman’s appearances have become media events, focusing public attention on the government’s economic policy and providing an opportunity for legislators to declare their preferences over the course of monetary policy (Havrilesky 1993).
Although most academic accounts of central bank independence do not emphasize this informational role in the policy process, a number of political economists recognize it. Fair (1979) argues that a central bank’s independence should be measured by its ability to publicize policy disputes with the government. Havrilesky (1994b) suggests that independent central banks function as “sound money oracles,” making regular anti-inflationary public pronouncements. Goodman (1992) argues that independent central banks build social and political constituencies, presumably by supplying expertise and information about monetary policy.
Providing information about the government’s monetary policy therefore represents one of an independent central bank’s most critical political functions. Party leaders can use the bank’s credibility to help build and maintain diverse social coalitions. An independent central bank can also help prevent intraparty conflicts over monetary policy and consequently help parties stay in office longer. That political function helps to explain the variation of central bank institutions across systems and over time.