Evan Soltas
Apr 24, 2012

Über Alles

Statistically examining Germany's influence over ECB policy

Over the last week or so, I've looked in depth at the Eurozone, sensing that risks have risen and that people are undervaluing the seriousness of emergent difficulties there -- new debt market pressures on Spain, rising political uncertainty in France and the Netherlands, etc.

Last Monday, for example, I derived a Taylor rule for the ECB and said a 50 basis point rate cut was coming, but that more significant reforms were needed to escape the dangers of the euro, which we really should start calling the worst idea in monetary policy since the gold standard. Yesterday, I gave up on the Eurozone, saying that monetary union's costs far exceeded its benefits, and that trying to "save" the Eurozone was not the right goal. I also derived an H-value, my measure which quantifies the stance of monetary policy, for the ECB.

In calculating that H-value, however, I assumed that the ECB weighted inflation and real growth in the Eurozone countries according to the sizes of their respective economies. That, however, is not a very good assumption. It's common knowledge that Germany's Bundesbank more or less directs ECB policy.

How true is that, exactly, statistically? In other words, what share of policy appears to be driven by stabilizing the German economy?

I looked at this by expanding my H-value model, which considered only two variables -- real growth and inflation -- in a loss function, to four variables -- real growth and inflation in Germany and in the Eurozone less Germany -- and then calculated their weights.For most of the ECB's history, stabilizing German inflation has been the single most important consideration of monetary policy. During the most recent recession, moreover, my program rejects the hypothesis that the ECB assigned any weight whatsoever real growth in Germany or the Eurozone for multiple quarters.

Although we can't derive an H-value exactly from this data, we can calculate what share German variables occupy in the composite variable we have determined the ECB has sought to stabilize since 2000. In short, Germany is half of what the ECB considers. The entire rest of the Eurozone is the other half. Given that the German economy is approximately 27 percent of Eurozone GDP, this is just under double the weight it would have if it was considered at par in terms of real GDP with the other Eurozone economies. (Which is how it should be considered.)This is a monetary policy equivalent of Deutschland über alles, and it explains the divergent outcomes in real growth (read: deep recessions) for the rest of Europe. When you put Germany in charge of the ECB, Germany considers what's right for Germany, and not what is right for you.