Introduction of The Value of Money Controversial Economic cultures in Europe: Italy and Germany

Together with Christiane Liermann, Thomas Mayer and Matteo Scotto, I have edited a book  on “The Value of Money Controversial Economic cultures in Europe: Italy and Germany” published by Villa Vigoni Verlag. Jean-Claude Trichet wrote the preface to the book. What follows is the introduction Thomas and I wrote. In an other post, I will publish my contribution to the book.

When the Bretton Woods system crumbled, and currencies lost their direct link to the dollar and their indirect link to gold, Germany and Italy embarked upon strongly different monetary policies. The divergence was reflected in the evolution of the exchange rates: the German currency rose from 170 lira under Bretton Woods parities to 990 Italian lira per D-Mark at the start of European Monetary Union. A stunning devaluation of the Italian relative to the German currency: about 83 percent! What is behind this development? Does it reflect opposite theoretical concepts and historically
constant differences in the institutional setup and the implementation mode of monetary policy? Is there an insurmountable Alpine divide between Italy and Germany that will jeopardize EMU’s future?

We have invited 22 experts, mostly from Germany and Italy, to give their views. The essays collected in this book do not pretend to give definitive answers to these questions. However, we can discern from the contributions a few hints. First, there is a difference in the emphasis on rules relative to discretion, which some commentators refer to as a “clash of cultures”. It will not come as a surprise to readers that German commentators put more emphasis on rules than Italian ones. Second, and related to the first, there are some differences of view on the relationship between monetary and fiscal policies. While in the Italian approach monetary-fiscal policy cooperation is considered very important, some (but by no means all) German commentators stress the need for monetary dominance. Third, the Italian view is more strongly in favour of putting the central bank in charge of banking supervision. Fourth, there is broad agreement that social and structural economic factors have been important in shaping attitudes towards money and monetary integration in both countries, with German commentators stressing the experience of hyperinflation after WWI and some Italian ones the fascist legacy after WWII. Fifth, some German commentators seem to take a somewhat more skeptical view on the future of EMU than their Italian counterparts. At the same time, however, there is also a considerable overlap of views north and south of the Alps in all contributions. Hence, our key takeaway from the collected essays is that crossing the Alps is not easy, but possible.

In the remainder of this section we give a brief review of the contributions, following their respective narratives rather than their order of appearance in the chapters. Tobias Piller, Ludger Schuknecht and Otmar Issing discuss the evolution of the Bundesbank as the domestically and internationally highly respected guardian of the DMark. During its relatively short history, the D-Mark became the second-most important international reserve currency and the anchor for many European currencies. However, the Bundesbank was feared by some as “the bank that rules Europe”, beyond any explicit decision to this effect. Piller identifies the trauma of German Hyperinflation in 1923 as a loadstar for the Bundesbank’s post-WWII policy and explains, from this vantage point, the skeptical attitude among many Germans towards the more recent evolution of the policies of the European Central Bank. He also writes of an apparent “obsession” of Germans for price stability and an independent central bank, which gives a sense of the
depth of attachment to their currency and central bank, as does the  eference by Issing to a “pathological relation” of Germans with their currency.

Ludger Schuknecht shows how the Bundesbank managed to achieve monetary dominance and navigated relatively successfully through the inflationary 1970s. Against this background, it went to great length to enshrine monetary dominance also in the design of the European Economic and Monetary Union. However, both Schuknecht and Piller are skeptical on the preservation of the legacy of the Bundesbank in EMU. “The integration process remains incomplete. This makes it much harder for the ECB to promote monetary dominance than it was for the Deutsche Bundesbank”, Schuknecht warns. As it will be seen below, Gunther Schnabl pushes this pessimism one step further, arguing that the gradual transformation of the European Central Bank from a German-type into a French-Italian-type central bank makes it “anything but ready for the next 20 years of monetary union”.

Otmar Issing agrees that the successful start of EMU and the credibility which the ECB and the euro enjoyed from the beginning would not have been possible without the widely shared view that the new European central bank was modelled on the German central bank. But he warns that it would be misleading to see the ECB as a clone of the Bundesbank. The European Central Bank has a much broader constituency than the Bundesbank had. Issing, however, rather than reaching the concerned conclusions of Piller and Schuknecht about the quasi-inevitable withering of the Bundesbank values, calls for their preservation through “transparency and wise decisions”.

Thomas Mayer points to the post-WWII emergence of a liberal economic order, in the spirit of the “Freiburg Ordo-Liberal School”, as a major contributor to Germany’s “economic miracle” and the ascendance of the Bundesbank. In line with the ordo-liberal tenets, Ludwig Erhard, the country’s first Minister of Economics and later Chancellor, firmly believed that economic policy should provide the institutional framework and sound money for private economic activities, while refraining from meddling in these activities. Mayer fears that these principles have been lost in the course of the Financial and Coronavirus Crises.

Pierluigi Ciocca sets the long process of monetary unification in a broader, long-term picture of the Italian economy. His perspective is definitely an Italian one, but it is not so different from that taken by Hans Helmut Kotz, as will be seen below. In particular he stresses that the desire of Banca d’Italia to achieve monetary stability was often frustrated by incompatible fiscal, wage and structural developments. In terms of intellectual underpinnings, Ciocca stresses the diversity of economic models used by the bank but also the rigour of its methodological approach, combining into what he denotes as “theoretically careful and empirically grounded eclecticism”. Ciocca also finds the main limit of the Bundesbank model in its disregard for Keynes’ main insight, that, investment oriented, fiscal expansion is, in some circumstances, essential.

Lorenzo Codogno presents “some stylised considerations on how the experience and history of the Banca d’Italia over the decades before monetary union helped it in the design and actual construction of the European Central Bank and in shaping how the monetary union has developed”. He stresses that one critical component of the Banca d’Italia experience, since its foundation in 1893, was the need to consider jointly the macroeconomy and the banking sector. It is on the basis of this experience that Tommaso Padoa-Schioppa insisted that financial regulation and supervision should be unified in a monetary union and that supervision should, contrary to the Bundesbank model, be the responsibility of the central bank. It is a pity that he would unexpectedly die before seeing this development come true, with generalized support. Banca d’Italia was also keenly aware of the importance of a sound institutional framework, to which it contributed over the decades. Codogno also stresses, along similar lines as those developed by Ciocca and Kotz, that “monetary policy alone was not enough to stabilise the system” and that the quest of Banca d’Italia for stability was frequently impaired by imprudent fiscal and wage policies as well as external shocks.

Giulio Tremonti takes, consistently with his long government experience, a fully political approach to the issue of EMU architecture. To argue his point, he looks at three periods: The Age of Peace (1943–89), The Age of  lobalization (1992–2007) and The Age of Crisis (2008–20). He is particularly critical of the prevailing narrative during the Globalization Age, emphasizing that he, among other Italians, stressed the “dark side” of globalization. Basically, his criticism is that there was too much emphasis on economic, rather than broader societal and political, factors and too little governanceof the process. Thus, the Age of Globalization nurtured the Age of Crisis. An episode that Tremonti recalls in vivid terms is the Trichet-Draghi letter of 5 August 2011, addressed to Prime Minister Berlusconi, that he identifies as a soft “coup d’état”. Tremonti welcomes the European  response to the COVID crisis in the fiscal domain: both the suspension of the budgetary rules and the Recovery and Resilience Fund. But he stresses that this is not enough, and even the euro is not enough. He calls for more: “what is needed in the growing vacuum forming around the euro is politics”. And this must include a “common European commitment to, and investment in, defence and security”.

Federico Fubini starts his contribution with a bang: “the ‘divorce’, that freed Banca d’Italia from any obligation to buy newly-issued government bonds in excess of market demand, was a failure”. This is a conclusion at variance with a number of other contributions in this volume, such as Codogno and Kotz. The rest of his article is dedicated to supporting this surprising conclusion. The basic arguments that he develops, matching long but illuminating quotations from Mussolini speeches with utterances from representatives of democratic Italy, is that Italy has maintained, albeit under a different and less visible guise, the corporatist culture developed by Fascism. The “divorce” succeeded in the narrow monetary area but failed in a broader context as it did not, indeed could not, really break the corporatist approach prevailing in Italy. This is a critical difference between Italy and Germany: in the latter country the Allies, after the end of the war, dismantled Nazi economic institutions, but they did not do the same in Italy, letting Fascist institutions survive.

Harold James starts by comparing the northern, “Germanic” economic philosophy with the southern, “Latin” philosophy: the northern vision is about rules, the southern one emphasizes discretion. However, he notes that the division between the two views is also visible within countries: the German government eventually abandoned its moral hazard concerns and supported the action of the ECB breaking the spiral of the Euro Crisis; some parts of Italian public opinion supported the strategy of “tying hands”, aimed at gaining the credibility that purely discretionary policies could not reach. The Euro Crisis led to a clash of cultures, which manifested itself first in the question of what sort of rules were needed to prevent rescue operations from creating moral hazard and then of who made and enforced the rules. The clash ended in a revulsion of the principle of conditionality, which became clear in the Coronavirus crisis. The question of “how to build consensus and civil community” remains open, says James.

Gertrude Tumpel-Gugerell takes up the issue of “clashes of culture” dealt with by James, making it more operational. Indeed, she identifies four such clashes which economic policy in the euro-area had to confront. All of them have to do with the definition of the responsibility of national with respect to European institutions and, specifically, in three of the four cases, with the responsibility of the central bank. The first clash is whether the central bank should intervene when negative developments in the bond market of one or the other member of the euro area endanger monetary union. The second clash of culture has to do with the division of responsibilities between national and European fiscal policy, in particular in crisis times. The third clash of culture is about the role of the central bank in assuring the stability of the financial sector, as opposed to the responsibilities of private agents and national governments. The fourth clash of culture relates to the responsibility of the central bank in stabilizing aggregate demand. Tumpel-Gugerell does not provide her definitive view on these four clashes of culture, but stresses the need to understand and bridge these cultural differences and offers her article as a contribution in this direction.

Fabio Colasanti dwells on the attitude of public opinion in Italy towards Germany and, in particular, the Bundesbank. He illustrates how legitimate complaints, exaggerations or genuine fake stories came about, stressing the need to understand the first while debunking the second and the third. The economic difficulties of Italy, in the nominal field in the 1970s, 1980s and 1990s and in the real field more recently, “created a strong reaction – a mixture of envy and an inferiority complex – that led a large part of the
Italian public to seek out an explanation in events taking place outside of the country and to thereby find foreign scapegoats. Many felt that it could not be that Italy, with its incredible cultural past, was doing so badly economically and socially”. One case of gradual development of a fake story reported by Colasanti is about “Italy having paid for German reunification”, where the true fact that interest rates in Europe were too high because of the consequences of reunification morphed in the view that Italy had actually financially contributed to the cost of German reunification.

Ivo Maes elaborates on the internal dimension of the differences towards European monetary integration, expanding the point made by James about differences within both Germany and Italy. Foreign policy views and makers were crucial in both countries in charting the EMU project at history making junctures, like the creation of the EMS and the Maastricht treaty. The foreign policy paradigms that informed the views and behaviour of the political authorities, in Germany and Italy, were shaped by idespread
pro-European attitudes and a federalist approach, deeply rooted in the history of both countries. The prime ministers of both Germany and Italy followed the foreign policy views at the crucial moments of the construction of monetary union. In contrast, the institutional framework of EMU was strongly shaped by the economic policymakers, in particular the Bundesbank. These policymakers were, especially but not exclusively in Germany, much more skeptical.

Francesco Papadia asks whether the higher monetary stability in Germany than in Italy after the collapse of the Bretton Woods system is a constant feature in the monetary history of the two countries. The answer is a definite no: since their national unification in the second half of the nineteenth century and until nowadays, even disregarding the German hyperinflation of 1923 and the instability during the years preceding the 1948 monetary reform, there has been less monetary stability in Germany than in Italy. The concrete implication Papadia draws from this result is that there is no ineluctable failure in merging into a single currency countries with very different monetary histories. What is critical is that the variables setting monetary policy, and in all likelihood fiscal policy as well, are appropriately chosen. The fact that Italy and Germany have never had as much monetary stability in their national history as they are having with the euro is an encouraging sign in this respect.

André Sapir points out that, although France and Italy had different internal dynamics, they defended the same “monetarist” approach during the Maastricht negotiation, which held that nominal convergence was not an indispensable precondition for monetary union and that the credibility of the new common central bank would achieve the objective of price stability regardless of past economic performance by the members of the monetary union. By contrast the “economist school”, sponsored mainly by Germany and the Netherlands, insisted that monetary union could only come as the final ‘coronation’ after a successful process of economic convergence. The Maastricht agreement was a compromise between the monetarist position, with a strict timetable for the introduction of the single currency, and the economist position, asking for strict convergence criteria before adopting the single currency. Sapir also notes that actual policy performance is more important than formal declarations. So, Denmark, after having obtained an opt-out in the Maastricht Treaty that did not oblige it to adopt the euro, had no problem in maintaining its currency inside the Exchange Rate Mechanism during the 1992 crisis, because of its commitment to prudent policies. Italy, instead, while committed to adopt the euro, entered the crisis in precarious conditions and with a domestically divided attitude towards exchange rate stability, finally succumbing to market pressure.

Daniel Gros stresses the importance that economic models had in determining the budgetary rules in EMU. To be sure, there was a discussion between Germany on the one side, and France and Italy on the other: political leaders in the former country wanted an assurance that fiscal policies would remain prudent, while those in the latter two countries wanted to preserve the freedom to run larger deficits. However, the latter lost out in the debate because the underlying intellectual framework of the time – inspired preeminently by US academics, but also eagerly adopted by central bankers and some economists in Italy – saw little value in discretionary fiscal policy and emphasised the importance of ‘rules versus discretion’. This was particularly important in a monetary union encompassing a number of sovereign countries, where external effects of domestic fiscal policies are particularly strong, while one cannot count on
financial markets disciplining imprudent fiscal policies.

Hans-Helmut Kotz starts from an illustration of the secular fiscal developments in Italy and Germany, noting that the behaviour of fiscal variables was similar until the late 1960s. Since that time developments were very different, while responding, in both countries, to social pressures: fiscal developments are not exogenous policy variables, but the
product of deeper, underlying phenomena. In particular differences in institutions governing or impacting labor markets and the way to solve conflicts about income distribution have consequences for both fiscal and monetary policy. Banca d’Italia had the same desire to achieve price stability as the Bundesbank, but was confronted with different, less favourable trade-offs. According to Kotz, internal structural economic differences between Italy and Germany, and not the Alps, are the dividing line. The difference in monetary developments in Germany and Italy between the demise of the Bretton Woods period and the birth of the euro has ultimately deeper reasons than just fiscal developments.

Lucio Pench carries out a forensic analysis of public finance developments in Italy and Germany since the beginning of the 1960s identifying five periods: the 1960s, the 1970s, 1980-mid 1990, mid 1990-2007 and 2008-2020. While in the 1960s, as also noted by Kotz, the two countries had similar fiscal developments, the 1970s saw the beginning of the differentiation between Italian and German developments. In the 1980-mid 1990 period both countries, albeit with different success, tried to regain monetary stability but “the pursuit of nominal convergence coincided, however, with
an explosion of the divergence in the public debt trajectories of the two countries”. In the second half of the 1990s and until the beginning of the Great Financial Crisis in 2007, the Great Moderation was visible in both Italy and Germany, and nominal stability was this time accompanied by a convergence, albeit partial, of Italian public debt towards the level prevailing in Germany. In the last period, Italian public debt first grew, then stabilized before jacking up again when the COVID-19 crisis struck. Pench then illustrates how the initial push towards higher debt levels caused by primary deficits between 1960 and 1990 perversely interacted with the “snowballing effect”, in later periods, given by a nominal cost of debt higher than income growth, making the Italian attempts at stabilizing the debt-to-income ratio a kind of Sisyphus torture, while Germany’s fiscal situation remained overall much more stable.

Klaus Masuch investigates the interaction between monetary and fiscal policy, stressing the need for them to work “hand in hand”. Indeed, in his view, policy cooperation has become more important as interest rates have approached the lower boundary (which may be below zero) and monetary policy alone has become less effective as a result. With this approach, Masuch goes beyond the stark alternative between fiscal and monetary dominance, proposing a more articulated policy set-up, in which the two policies exploit, so to say, their comparative advantages. This creates, however, problems in a monetary union, where the central bank has to deal with multiple sovereign fiscal entities. In an environment of very high sovereign debt in a few countries, debt restructuring or a tax on private wealth may have to come on the agenda to pave the way for future economic growth.

How will EMU cope with the numerous challenges already visible today or coming up in the next 20 years? Gunther Schnabl comes to the definitive conclusion that EMU, and specifically the ECB, is not up to the task. The basic reason is that “[…] the common central bank was gradually  transformed from a German-type into a French-Italiantype central bank model”, less and less trusted. It is remarkable that this conclusion is diametrically opposite to that of Ciocca according to whom “many Italian economists therefore miss the pre-1998 Banca d’Italia, which in many respects they linked to the Fed”. In addition, the central bank is now burdened with additional tasks “such as stabilizing the financial system, safeguarding the euro and even protecting the climate”. He identifies the euro as a straightjacket in a much less than optimal currency area, which
suffers from significant divergence in real economic developments. While a break-up of the euro-area “would help a return to the pre-euro currency competition, which would foster growth and welfare in Europe”, it would also lead to strong turbulences in financial markets and growing political uncertainty. As intermediate solution, Schnabl demands more exchange rate flexibility, possibly through the introduction of national parallel currencies alongside the euro.

Pier Carlo Padoan offers a conditional answer to the question whether the ECB is ready for the next 20 years of monetary union, quite in contrast with the much more definitive, negative, view of Schnabl. Padoan looks at developments in the euro-area from an economic policy perspective, consistently with his experience as economic minister, but not forgetting the analytical perspective of the former economics professor. Consistently
with the history-oriented conclusions of Ciocca, Codogno and Kotz, Padoan stresses that “monetary policy alone cannot bear the burden of supporting the EZ economy. ECB action must be complemented with fiscal and structural policies”. In the fiscal area, in particular, Padoan sees the need for a common fiscal capacity. The Next Generation EU plan is a welcome, significant step in this direction. However, the “ECB will be ready for the next two decades of monetary union also to the extent that the contribution of policies other than monetary policy will take on a larger role than in the past in the support to growth and stability”. This will also allow the ECB to gradually unwind its unconventional policies.

Sabine Seeger takes a normative approach to the question of the international role of the euro. She explains how the euro has already established some of the conditions leading to an international role: its stability, the substantial advances on banking union, the large economy that it serves but is at the same time its basis, its second place, after the dollar, as international currency, its use as a linchpin for a number of currencies outside of the euro-area, the changing attitude towards the international role of the euro by euro-area governments as well as the European Central Bank. In prospective terms the Next Generation EU plan can likewise reinforce the international role of the euro. Seeger also notices, however, the remaining limitations hampering a wider international role for the euro, recalling the missing “unions” identified by the five Presidents report of 2015. Seeger does not shy away from noting, as also Tremonti concluded, that a common foreign and security policy is also needed to fully support an international role for the euro. At the end, however, there is a tone of confidence in her article that, although gradually, Europe will be able to establish the basis for a stronger international role of the euro.

Stefano Micossi shares much of the analysis of Seeger, but he adds a critical question: do “we Europeans really want this greater international role for our common currency, given its broader implications for internal macro-economic and regulatory policies”? If the desire was there, the preconditions for this greater role for the euro could be, although in a progressive way and with some difficulties, created. As also noted by Seeger, the euro is clearly the second most important international currency, albeit at quite some distance from the dollar. The euro area economy is large and open, but its capital market has not grown, in size and sophistication, as the Capital Markets Union project promised. An asset with the liquidity and the size of the America treasury paper is still missing and various initiatives to gradually create it have not led to decisive progress as yet. While the outstanding hurdles could be surpassed, with sufficient determination and common engagement, Micossi confesses his inability to answer the question whether Europeans really want their currency to take a larger global role. Hence the remaining question mark to the title of his article.

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