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Rules, Discretion, and Central Bank Independence: The German Experience 1880-1989

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  • Bernhard Eschweiler
  • Michael D. Bordo

Abstract

Theories of rules and discretion suggest that monetary policy rules are first best in terms of social welfare. However, if commitment is not feasible, delegating monetary policy to an independent and conservative central bank can be second best. Monetary policy in Germany during the past one hundred years provides an excellent case to assess the empirical evidence on the use of rules and central bank independence in monetary policy making. Since the creation of a central monetary authority in 1876, Germany has participated in four monetary regimes: the pre-war gold standard, the inter-war gold standard, the Bretton-Woods system, and the floating exchange rate regime. The bottom line of our analysis is that monetary policy in Germany was always geared toward maintaining price stability with the exception of the two world war periods. Germany relied both on rules and discretion with central bank independence to achieve the goal of price stability. A comparison of the Classical Gold Standard regime with the floating exchange rate regime suggests that society under the floating exchange rate regime with central bank independence was better off. However, this comparison ignores the historical difference in output shocks and the possibility that society became more inflation averse over time.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4547.

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Date of creation: Nov 1995
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Publication status: published as Pierre Siklos, ed., Varieties of Monetary Reform: Lessons and Experience on the Road to Monetary Union. Boston: Kluwer Academic Publishers, 1994, pp. 279-321.
Handle: RePEc:nbr:nberwo:4547

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  1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 589-610, August.
  2. Maurice Obstfeld, 1993. "The Adjustment Mechanism," NBER Chapters, in: A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform, pages 201-268 National Bureau of Economic Research, Inc.
  3. Bharat Trehan, 1988. "The practice of monetary targeting: a case study of the West German experience," Economic Review, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Spr, pages 30-44.
  4. Richard C.K. Burdekin & Leroy O. Laney, 1986. "Fiscal policymaking and the central bank institutional constraint," Research Paper, Federal Reserve Bank of Dallas 8606, Federal Reserve Bank of Dallas.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Nordhaus, William D, 1975. "The Political Business Cycle," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 42(2), pages 169-90, April.
  7. Bradley, Michael D & Potter, Susan M, 1986. "The State of the Federal Budget and the State of the Economy: Further Evidence," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 24(1), pages 143-53, January.
  8. Fratianni, Michele & von Hagen, Jürgen & Waller, Christopher, 1992. "From EMS to EMU," CEPR Discussion Papers, C.E.P.R. Discussion Papers 618, C.E.P.R. Discussion Papers.
  9. Alberto Alesina, 1988. "Macroeconomics and Politics," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 13-62 National Bureau of Economic Research, Inc.
  10. Michael D. Bordo & Barry Eichengreen, 1993. "A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform," NBER Books, National Bureau of Economic Research, Inc, number bord93-1, October.
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Cited by:
  1. Michael D. Bordo & Anna J. Schwartz, 1994. "The Specie Standard as a Contingent Rule: Some Evidence for Core and Peripheral Countries, 1880-1990," NBER Working Papers 4860, National Bureau of Economic Research, Inc.

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