Bundesbank faces dilemma over downturn and high inflation: John Eisenhammer looks at the issues that the central bank's council must address when it meets on Thursday

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The Independent Online
THE RASH of recent monetary policy statements from the Bundesbank suggest it is increasingly uncertain about whether to respond to the mounting evidence of a downturn or to the continuing problem of inflation.

The list of announced job cuts by flagship enterprises of the German economy continues to lengthen. Industrial orders fell in August for the sixth month in succession. In its September report, the Bundesbank wrote that the 'uncertainty about the further development of the economy has undoubtedly intensified'.

Much harsher than the domestic criticism, however, has been the onslaught from abroad on the destabilising effects of Germany's high interest rate policy. The self-assurance of the bank's president, Helmut Schlesinger, has been badly hit by the trauma of the past month.

During the 1980s Mr Schlesinger's name became synonymous with the Bundesbank's obsessive adherence to tight monetary parameters in its fight against inflation. Otmar Issing, who has taken over Mr Schlesinger's former job as the central bank's 'chief ideologue', now has the task of protecting this monetary guide as the central element in the Frankfurt conventional wisdom.

But even these two commmitted monetary target crusaders are now conceding that M3, the broad money measure which includes bank accounts, is proving an unreliable guide. With the high interest rates caused by unification, investors have switched massively from long- into short-term deposits. Also, investors in eastern Germany, even if they own capital, prefer to borrow from banks as this entitles them to generous government subsidies. The result has been a strong boost to M3 growth.

The massive European currency interventions of last month mean that M3 growth in September will show an abnormal spurt. Already in July, when the Bundesbank raised the discount rate by 0.75 percentage points to 8.75, Mr Schlesinger acknowledged the artificial element in M3 expansion because of unification, but rejected any relaxation. However, senior Bundesbank figures have been laying greater emphasis over the past week on the need for a more flexible interpretation.

Those analysts who eagerly seized upon this as a sign that money market easing is on the way were further encouraged when Mr Issing said last week: 'It is probable that with the slowing down of the economy the money supply will drop after November, and then we shall assess the circumstances'. The self-doubt that these statements suggest has been sharpened by the evidence of a downturn.

While it is still too early to talk of recession, the drop from the post-unification consumer boom to the present real growth level of about 1 per cent has been vertiginous. Having enjoyed capacity stretched to the limit two years ago, companies are now cutting back.

Yesterday Siemens, the engineering giant, announced that weak market demand would force it to slash 3,500 jobs worldwide over five years in its semi-conductor operations.

Deutsche Aerospace is to cut 7,500 jobs by the end of 1994. Porsche is to lose nearly 2,000 jobs by next summer, and Mercedes Benz, whose domestic car sales dropped 18 per cent in the first nine months of this year, is cutting 10,500 jobs this year with another 10,000 to follow. A recent poll among medium-sized firms said they expect a 0.5 per cent decline in GNP over the next six months.

But the dilemma for the Bundesbank is that inflation in Germany is obstinately refusing to decline. After reaching a low point this year of 3.2 per cent in July, it went up to 3.5 per cent in August and was 3.6 per cent last month. The 1 per cent increase in VAT due in January 1993 will raise prices.

The other main reason for high rates is the continued stimulus from public spending. As Otto Graf Lambsdorff, leader of the Free Democratic party, a coalition member, said yesterday, there is almost no chance of containing government spending below 2.5 per cent.

Finally, there is the matter of the 1993 wage round. Last year, at the opening of the round, the Bundesbank raised rates. Peter Muller, Bundesbank watcher at Commerzbank, said: 'It would be a curious signal if this year the Bundesbank were to choose that moment to lower rates, given that none of the things it is meant to worry about have improved at all.'