"Competitive Deflation" Model

The German Bundesbank is reputed for its high independence from the federal government in implementing its anti-inflationary policy throughout the latter half of the20th century. Unlike the government's concern on employment and growth, the Bundesbank saw the price stability as the sole objective and adopted a deflated policy stubbornly. Generally, politicians were more inclined to conduct an easing policy to fill the gap of effective domestic demand, which was very popular under the Keynes paradigm before the stagflation in1970s. For many times, the Bundesbank conducted a tighten policy in order to restrain arising or potential inflation. Therefore, Conflicts between the federal government and the central bank were very frequent and unavoidable. However, the inflation-averse policy was proved by German glorious growth, and the Deutsch Mark was seen as a symbol of German long and sustainable prosperity. As a result, the Bundesbank's way of policy was ultimately accepted by the federal government.It is a long process before the government recognized that the Bundesbank's policy posed no threaten to the government's policy. A variety of researches have been conducted on how the Bundesbank managed to be independent from the government's intervention and similar conclusion has been made that it was depended on German unique history and stability culture. The Hyper-inflation in1923first made the German people aware of the Weimar Government's incredibility and that pulled the Nazi onto the political stage. Unfortunately, the Reich Mark's ineffectiveness in Nazi's price-controlled economy even made people more desperate. Thus, at the end of the world war II, what people want most was a more credible and independent central bank. It was the occupation authority of Allied Army who initiated the1948central bank policy reform saved the German Mark. The newly redesigned Bundesbank was first copied from the Federal Reserve's Mode, and then the1957reform ultimately made it a typical German style independent central Bank. In the time aftermath, the Deutsch Mark witnessed a high economic growth of post war era and German reunification. The Bundesbank did a historical performance in keeping a low and steady inflation. However, during the German reunification in1989, the Bundesbank also adopted a radical and abnormal way of easing monetary policy in order to comfort the pains of the East Germans. At the turning of the new century, the Mark left the stage and the Euro elongates the Deutsch Mark's performance.The motivation of the thesis is to redesign the theoretic framework of "Competitive Disinflation" which was first given by Jean-Claude Trichet as the former French financial minister in1983. Basically,"Competitive Disinflation" is a process of competitiveness gaining through adopting anti-inflation policies of the central bank and strict austerity measures from the government."Competitive Disinflation" is deeply rooted in the long history with unique culture of German society and economy. The article tries to redefine the attributes of the "Competitive Disinflation" under the framework of the Freiburg School, German social market economy, and to differentiate German-type Neo-liberalism from the main stream of Neo-liberalism. Clearly, in the scenario of the disinflation, expansionary macroeconomic policies are typically restricted. The "Competitive Disinflation" provides a framework of non-interventionism for either government or the central bank, and an independent central bank is at the heart of the framework.The Bundesbank had its own distinctive way to implement monetary policy compared with the Fed and many other central banks in the post Breton Woods time. One obvious feature of the Bundesbank's policy was to announce annual monetary target since1975and that really worked well and had cooled down the markets' expectation of potential inflation for decades. More than that, theoretic model shows that low inflation expectation not only helps to keep a misaligned real exchange rate, but also helps to maintain a stagnated wage pricing through the Bundesbank's signaling function in the collective wage bargaining. For the exchange rate misalignment, the thesis tries to analyze it in the BEER approach to test Deutsch Mark and the Euro respectively and find that German currencies in different period are clearly undervalued. For the labor cost, the article intends to define the interaction process of the Bundesbank, the Federal government and trade unions in a triangle, and finds that trade unions will adopt a conservative way when facing of the potential policy response of the Bundesbank if their wage raising would cause certain degree of inflation. Furthermore, in the framework of "Competitive Disinflation", the government would also adopt some similar steps to coordinate with the Bundesbank's signaling and suppress the trade unions'behavior through income tax and labor market reform. In a conclusion,"Competitive Disinflation" is a policy model or framework, in which the central bank plays a dominant role, the government and other social partners coordinate with each other. Non-expansionary macroeconomic measures are at the heart of the process.The European Central Bank inherits most of the instincts of the Bundesbank, for instances, similar strategy of price stability and monetary targeting, that it is deemed a complete copy of the Bundesbank. Nevertheless, rather than the scale of German economy, the emulation of the ECB was the result of the German economic model and its success experience in maintaining competitiveness, basically, it is the persuasive power of the Bundesbank's anti-inflation practice, the government's austerity behaviors, and the confidence hold by politicians of other member states that Germany's success could be replicated on the EMU level. Seen from the laws which backed the ECB, the SGP and TFEU particularly identify the clauses of price stability, central bank's role and fiscal policy discipline, a complete copy from German laws. However, in facing of the current imbalance in the Euro area, the article tries to further explore the competitive factors from the perspective of feasibility of "competitive disinflation" in the Euro area. Empirical studies show that "competitive disinflation" is not equally functioned across the Euro area, particularly it is not performing well in periphery countries. Therefore, one of the main conclusions is that unlike other member states, the unparalleled performance of Germany in the crisis indicates that "competitive disinflation" model in the Euro framework is one key factor in driving current economic turmoil in the Euro area.The Article tries to debate on the imbalanced influence of "competitive disinflation" on Euro area export competitiveness thus to certify that Germany still benefits from the dividend of "competitive disinflation" in the Euro system. Empirically findings show that German exportation is not only solely promoted by high tech factor, but also benefited from suppressed labor cost and misaligned real effective exchange rate. For those export-oriented developing countries, the German model could give an inspiration for their domestic reform. As a matter of fact, the policy heritage of Deutsch Mark and the Bundesbank is not only beneficial to EU, but also other countries. The strategic importance of central bank independence has been accepted by many countries. They are getting known that a low inflation can help to main a low real effective exchange rate and low labor cost. Empirical findings of the article have also proved an evident negative relationship between low inflation and export competitiveness.