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A Monetary Nightmare
at the Bundesbank

The European Central Bank faces a dilemma: it is quite difficult, today, to design a proper monetary policy for the whole euro zone. The open severe critiques coming from the Bundesbank, the German national central bank, are a foolproof sign of a conflict of objectives.

The problem is not the real economy. The euro zone is in recession, and the PMI manufacturing indexes for March (an indicator of the activity levels) showed «a surprising convergence of core towards peripheral countries», as François Cabau, economist at Barclays, puts it: economic conditions in Germany, as in France, worsened, meanwhile Italy and other peripheral countries were more resilient.

The problem lies on the monetary side of the economy. For the ECB, the supply money is the only relevant, indirect and imprecise policy lever, now that interest rates are near to zero: even if official rates are at 1%, Eonia is around 0.38% and 1-week Euribor is around 0.32%. So, the two three-year ECB LTROs – long term injections of liquidity – are considered by many economists as the euro zone version of quantitative easing.

The issue is that the money supply is unevenly distributed. German data are updated to December and show that the German contribution to the narrow measure of money M1– except, as usual for individual member states in Euro zone, currency – increased at a 5.4% annual rate. This compares with a contraction of 2.7% in Italy (-5.5% in February), meanwhile M3 grew by 1.7% (2.5 in February) in Euro zone. The for medium and the broad measure of money followed the same path: for M2 the country contribution grew by 6.6% in Germany, 0.6% in Italy (+1.31% in February) and Euro zone M2 expanded by 1.8% (2.8%); for M3 the country contribution expanded by 6% in Germany and declined by 4.4% in Italy (-1.4%), while Euro zone M3 increased by 1.6% (2.8% in February). The ECB reference annual rate of growth for M3, a forgotten but never abolished benchmark, is at 4.5 per cent.

For Germany this is a nightmare. It is true that money growth affects consumer prices only in the long run, but it can lift asset values in a shorter time span; and house prices, in Germany, are increasing for the first time in years. It is equally true that those monetary contributions by individual countries are not monetary aggregate in a technical sense, but only inaccurate proxies of the national money supply. It is nevertheless a fact that in Italy, and in other peripheral countries, those measures are contracting, or are near stagnation; and that  they run too quickly for the Bundesbank tastes, just now that – for the first time in the euro zone history – its influence on the ECB fades. This can explain the German nervousness, and the European Central Bank difficulties.