Volker Wieland, IMFS and German Council of Economic Experts

The German economy feels the repercussions of the global economic slowdown. The ongoing trade disputes and the circumstances of the Brexit cause uncertainties. Also decreasing demand from China for German capital goods becomes noticeable. Germany’s industrial sector is already in a recession. Apart from that, there are further challenges such as the digital transformation and the demographic change. At the presentation of the annual report of the German Council of Economic Experts entitled “Dealing with Structural Change”, Prof. Volker Wieland explained the Council’s assessment of the current situation.

Due to Germany’s exposed role in export, fluctuations in economic growth are not unusual, Wieland said. “However, in contrast to the start of the financial crisis in 2007/08, the service industry is still robust and the construction sector is booming”. In his opinion, an economic stimulus package is currently not necessary. Instead, dealing with the structural changes is essential. As in many industrial nations, labor productivity in Germany is decreasing, the number of newly founded companies is declining. Therefore, the Council considers it appropriate to foster innovations rather than to reinvent industrial policy. The participation of women and older people in the labor market should also be increased in order to tap remaining potentials. In some sectors, international coordination is crucial. Wieland cites as examples climate protection as well as research and development.

Regarding monetary policy, there is currently no need for action, according to Wieland. Monetary policy is still expansionary in the euro area. The decision of the European Central Bank (ECB) in September to resume purchasing government bonds was not necessary. “This was President Draghi’s farewell gift to the financial markets,” Wieland said. The new President Lagarde will be “on autopilot” for the time being. In his opinion, there are several approaches for the review of the ECB strategy. In order to assess whether price stability has been achieved, the ECB focuses on the Harmonized Index of Consumer Prices (HICP). Other measures such as the GDP deflator, which contains all goods and services and therefore also capital goods, are not considered in ECB communication. However, based on the GDP deflator, inflation was in line. Alternatively, Wieland refers to the PCE deflator. The Personal Consumption Expenditure deflator index measures the prices paid by consumers for goods and services and is the Fed's preferred measure of inflation. “From the Fed’s point of view, inflation development would have been a success,” Wieland concluded.

Slides of the presentation (PDF)

Matthew D. Shapiro, University of Michigan
Big Data - Implications for Central Banking

As big data and digitization affect many sectors and industries, central banks are also experiencing a paradigm shift where they combine surveys and big data. In his lecture in the IMFS Working Lunch series, Matthew D. Shapiro, Professor of Economics at the University of Michigan and Director of the Survey Research Center at the Institute for Social Research, shared his insights on how central banks could drive inferences from big data about the structure of the economy and the behavior of households and firms for policy actions.

In fact, “big data is not a new topic for central bank”, Shapiro stated, referring to the Fed’s Beige Book as very qualitative data on regional business conditions. In his view, the most progress in using big data for macroeconomic analysis had been made with high-frequency measures of real activity. There were also high-quality indicators from official sources on real economic activity such as employment, sales and GDP-basis data. However, he pointed out several shortcomings: The surveys are based on small and deteriorating samples, often there is a mismatch of price and revenue data and the revenues come with a high cost and burden. On the other hand, big data provides a ground truth for validating more novel measures. They also had granularity, which means that higher frequency and finer resolution at the geographical, product, or industry level could potentially lead to better informed decisions. Moreover, by getting closer to source data, real-time indicators might have better quality, Shapiro argued.

Nevertheless, making use of big data involved practical challenges for central banks as naturally-occurring data are typically more volatile than official statistics, or might confront economists with many sources of variation that were not present or had been smoothed out in official statistics.

So far, efforts by the Federal Reserve in the use of big data has focused on spending and employment. According to Shapiro, expanding the source of data on prices was likely even more important for the conduct of monetary policy. He called on the government and its statistical agencies to engineer a paradigm where households and business are willing to feed their data for statistical purposes much in the way they are willing to complete surveys. Moreover, this measurement improved by big data might have further implications: “Economists need to be open to the possibility that it might significantly alter assessments of economic performance”, Shapiro said.

Presentation (PDF)

Prof. Volker Wieland, IMFS and German Council of Economic Experts
Setting our for a new climate policy

Currently, the climate policy of the German government is not sufficient for reaching the climate goals in the year 2030. Numerous proposals for a new climate strategy have been put on the table. According to the German Council of Economic Experts (GCEE), establishing a uniform price on carbon dioxide (CO2) is crucial.

At the request of the government, the economic experts developed suggestions for national climate protection measures comprised in a special report, which Prof. Volker Wieland presented during an IMFS Policy Lecture in Frankfurt. “Cost efficiency is the report’s key element,” Wieland explained. Since greenhouse gases were produced during the economic process, they could not simply be banned similar to CFC.

The council members prefer the integration of the transport and buildings sector into the existing emissions trading system (EU ETS) instead of introducing a CO2 tax. In their view, the current experience with the EU ETS shows how emissions can be saved in a functioning system while the economy is doing well. A planned economy approach with a CO2 tax would not have the expected impact, Wieland warned. “It’s not about generating revenue for the state but the aim is to change habits”. In a market-oriented approach, emissions were reduced where it was most efficient. Moreover, with a CO2 tax the price for emissions was fix whereas in the emission trading system the output was defined. “The higher the price for emissions the bigger is the incentive to avoid them”, Wieland said.

In order to set a uniform CO2 price at a European level, all relevant sectors should be integrated into the trading system by 2030 at the latest, according to the council. However, Wieland does not recommend Germany to aspire to lead the way in climate policy. This could promote freeloader behavior. Instead, Wieland favors a give and take in the international climate negotiations. For one thing is clear: a global approach in climate protection is essential.

Presentation (PDF)

Ulrich Bindseil, European Central Bank (ECB)
Central Banking Before 1800 – A Rehabilitation

Usually, the Swedish central bank, founded in 1668, and the Bank of England (BoE) in 1694 are referred to as the oldest European central banks. In his Working Lunch, Ulrich Bindseil looked back at the origins of central banking, arguing against the prevailing view. Bindseil, who is Director General Market Operations at the European Central Bank (ECB), analyzed the charters of various earlier European continental institutions and examined whether these banks had a policy mandate and were based on a concept of central banking. Also the principle of lender of last resort, a key characteristic of constituting a central bank, is said to have developed only in the course of the 19th century.

According to Bindseil, however, already before 1800, more than 20 institutions fulfilled the definition of central banks. He found that the first institutions whose business model consisted in issuing central bank money with particularly short-term liabilities acting on the ground of specific policy objectives dated back to 1401 when the Taula de Canvi in Barcelona was founded, or the beginnings of several banks in the Italy, such as the Casa di San Giorgio in Genoa (1407), the Banco di Rialto in Venice (1587) or the Naples banking system (1580). Also the Hamburg Bank (1619) and the Nürnberg Bank (1621) rank among these early institutions. “Machiavelli referred to the Casa di San Georgio as a state in a state”, Bindseil explained their prominent position.

From the very beginning of central banking, lending to government is a recurring topic. The Casa di San Giorgio and the BoE both go back to the need of finding a framework for organizing the creditors of government. Based on his analysis of the pre-1800 central banks' balance sheet structure, Bindseil found that “the Bank of England from the beginning had a large loan given to the crown”. Also the Riksens Ständer Bank, the precursor institution of the Swedish Riksbank, had been financing the Swedish government during large periods of the 18th century. The first central banks were mostly established in democracies. As Bindseil further explained, there was a wide belief that central banks couldn’t be established in a monarchy with the Bank of England set aside as a constitutional monarchy.

Comparing the past with the current situation, Bindseils emphasized that the definition of eligible collaterals in the lending to private borrowers and the concept of a lender of last resort as a financial stability related function were constant topics over time. Altogether, in Bindseil’s opinion, the history of central banking goes beyond the Swedish central bank and the BoE. “If you apply these concepts then it’s hard to believe  that central banking was invented by Riksens Ständer Bank”, he concluded.

Presentation: "Central Banking Before 1800 - A Rehabilitation" (PDF, 1,7 MB)

Dr. Michael Heise, Allianz
Inflation Targeting and Financial Stability

Over the last decades, government bond yields have been falling drastically in advanced economies along with long-term interest rates. In his Working Lunch, Michael Heise, chief economist at the insurance group Allianz, scrutinized recent developments in monetary policy and suggested building a broader index of price stability.

According to Heise, the general rule of thumb that the long-term bond rate should correlate with long-term growth of GDP no longer holds true. “Monetary policy and not fundamental factors has put down interest rates”, Heise said. Looking at the negative side effects of a low-interest rate environment, Heise warned against a situation as in Japan that suffered a balance sheet recession after a financial crisis. In Japan, the accumulation of non-performing loans (NPL) inhibited banks from giving new loans and zombie firms were kept alive.

Furthermore, as a consequence of the current low-interest rate environment in the euro area, asset prices and especially housing prices have been increasing. Simultaneously, risks were building up in investors' portfolios. According to Heise, the BBB components in investment grade indices were continuously rising. “Investors are going up the risk ladder, searching for yields”, Heise said. Imbalances are also building up in the target system.

Comparing the unconventional monetary policy measures of the European Central Bank (ECB) and inflation development, Heise concluded that “inflation has its own life”. In his opinion, the ECB should define price stability targets in a more adaptable way, moving the focus away from a simple year-on-year target for consumer price inflation.

Instead of relying exclusively on the Harmonised Index of Consumer Prices (HICP), Heise suggested building a broader index which also reflects inflation expectations. Since in a financial boom risks are building up that could hit back when the economy is slowing down, the ECB should also put greater weight on developments in the financial cycle. According to Heise, “this is quite difficult and requires tough decisions but they need to be taken”.

Inflation Targeting and Financial Stability (PDF)