German Monetary Targeting: A Precursor to Inflation Targeting

Many features of the German monetary targeting regime are also key elements of inflation targeting the other countries examined this study. Indeed, as pointed out Bernanke and Mishkin (1997), Germany might best be thought of as a hybrid inflation targeter, that it has more common with inflation targeting than with a rigid application of a monetary targeting rule. The German experience with monetary targeting, which spans more than twenty years, provides useful lessons for the successful operation of inflation targeting, and this is why we study the German experience here. Several themes emerge our review of Germany's experience with monetary targeting:(1) * A numerical inflation goal is a key element German monetary targeting, suggesting that the differences between monetary targeting as actually practiced by Germany and inflation targeting as conducted by other countries are not that great. * German monetary targeting is quite flexible: convergence of the medium-term inflation goal to the long-term goal has often been quite gradual. * Under the monetary targeting regime, monetary policy has been somewhat responsive the short run to real output growth as well as to other considerations such as the exchange rate. * The long-term goal of price stability has been defined as a measured inflation rate greater than zero. * A key element of the targeting regime is a strong commitment to transparency and to communication of monetary policy strategy to the general public. THE ADOPTION OF MONETARY TARGETING The decision to adopt monetary targeting Germany, though prompted by the breakdown of the Bretton Woods fixed exchange rate regime, was a matter of choice. Germany was not under any pressure at the time to reform either its economy general or its monetary regime particular--in fact, the breakdown of Bretton Woods was part due to the extreme relative credibility of the German central bank's commitment to price stability and the concomitant appreciation of the deutsche mark. Under these circumstances, the loss of the exchange rate anchor was not the sort of credibility crisis where macroeconomic effects demanded an immediate response, as demonstrated by the slow (two-to-three-year-long) move to the new regime. Close analysis of the historical record suggests that two main factors motivated the adoption of monetary targeting Germany. The first factor was an intellectual argument favor of a nominal anchor for monetary policy grounded an underlying belief that monetary policy should neither accommodate inflation nor pursue medium-term output goals.(2) The second factor was the perception that medium-term inflation expectations had to be locked when monetary policy eased as inflation came down after the first oil shock. The generalization over time of this latter motivation--that monetary targeting provides a means of transparently and credibly communicating the relationship between current developments and medium-term goals--was the guiding principle of the newly adopted framework Germany. On December 5, 1974, the Central Bank Council of the Deutsche Bundesbank announced that from the present perspective it regards a growth of about 8% the central bank money stock over the whole of 1975 as acceptable the light of its stability goals.(3) The Bundesbank considered this target to provide the requisite scope . . . for the desired growth of the real economy, while at the same time the target had been chosen in such a way that no new inflationary strains are likely to arise as a result of monetary developments. Since 1973, the Bundesbank had used the central bank money stock (CBM) as its primary indicator of monetary developments, but never before had it announced a target for the growth of CBM or any other monetary aggregate.(4) Although this was a unilateral announcement on the part of the Bundesbank, the announcement stressed that in formulating its target for the growth of the central bank money stock [the Bundesbank] found itself full agreement with the federal government. …