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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.

Suggested Citation

  • Bernhard Eschweiler & Michael D. Bordo, 1993. "Rules, Discretion, and Central Bank Independence: The German Experience 1880-1989," NBER Working Papers 4547, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4547
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    References listed on IDEAS

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    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    2. 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, vol. 91(4), pages 589-610, August.
    3. Alberto Alesina, 1988. "Macroeconomics and Politics," NBER Chapters,in: NBER Macroeconomics Annual 1988, Volume 3, pages 13-62 National Bureau of Economic Research, Inc.
    4. 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, vol. 24(1), pages 143-153, January.
    5. Burdekin, Richard C K & Laney, Leroy O, 1988. "Fiscal Policymaking and the Central Bank Institutional Constraint," Kyklos, Wiley Blackwell, vol. 41(4), pages 647-662.
    6. 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.
    7. Fratianni, Michele & von Hagen, J├╝rgen & Waller, Christopher, 1992. "From EMS to EMU," CEPR Discussion Papers 618, C.E.P.R. Discussion Papers.
    8. 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.
    9. William D. Nordhaus, 1975. "The Political Business Cycle," Review of Economic Studies, Oxford University Press, vol. 42(2), pages 169-190.
    10. Bharat Trehan, 1988. "The practice of monetary targeting: a case study of the West German experience," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 30-44.
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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.

    More about this item

    JEL classification:

    • N13 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - Europe: Pre-1913
    • N14 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - Europe: 1913-

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