Bundesbank's role in ERM crisis

I am loath to rush to the defence of the 1992 Major government and its decision to leave the European exchange rate mechanism in September 1992 (Tories cry foul over secret papers, February 10), but an important feature of monetary politics in that year is being seriously underplayed, namely the extraordinary behaviour of the Bundesbank.

Yes, the desperate manoeuverings by the Treasury were hapless and costly, but the Bundesbank had driven central bank rates to historically record levels that year, the high point of the longest deflationary squeeze in Germany's postwar history. The bank's public justification of its policy focused on the need to choke off the signs of accelerating inflation resulting from unification. However, if one compares the length and intensity of the 1989-1995 squeeze with earlier periods of deflationary politics, it is clear that rates of inflation and money supply growth were higher in 1972-75 and 1979-83, and that the Bundesbank's policies were out of all proportion to the ostensible cause.

The bank's real agenda was arguably to stall or even to hinder the realisation of European monetary union and the loss of its policy dominance. Just three days after the draft Maastricht treaty was agreed in December 1991, the Bundesbank raised both its key rates by 50 basis points and raised the discount rate in July 1992 by a further 75 points. The policy was entirely dysfunctional. It choked off growth in most EU countries and drove the west German economy into its deepest ever recession in 1993. Despite the failure to prevent EMU, its dead hand remained in place in the shape of a disastrous deflationary orthodoxy which has blighted fiscal policy and growth in Europe ever since.

Above all, it has contributed to the woes of the German economy by hindering the convergence of the backward east German regions with the west and reinforcing their dependence on massive fiscal transfers from the west for many years to come. By all means enjoy Norman Lamont's blushes, but don't forget to put it in context.
Jeremy Leaman
Author, The Bundesbank Myth
Leicester