VW affair and the euro
How to lose German rule-making credibility
by David Marsh
Tue 29 Sep 2015
Prof. Charles Goodhart, the distinguished British economist and former member of the Bank of England’s monetary policy committee, and Volkswagen, the German car giant, were both born within a few months of each other, in October 1936 and May 1937 respectively. There, you might think, the similarities end. But there’s more to it than that.
Our good and now not-so-distinguished friends at VW have just demonstrated – in a striking way that is reverberating around Europe and the world – the fundamental truth of a ‘law’ Goodhart formulated, with regard to monetary targets, about 40 years ago. ‘Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.’
In other words, when the authorities start to measure some kind of variable and use it as a barometer of policy and performance, the parameter ceases to hold meaning. Once a measure becomes a target, it loses its validity, as VW – in literally breath-taking manner – has shown with its clinical use of engineering and software to sidestep controls on harmful emissions.
The VW affair is likely to have repercussions for monetary union because, in this matter of truth, trust and statistics, we have been here before. With some strong-arming from its friends like President François Mitterrand, Germany agreed to give up its currency after unification in 1990 on condition that its European partners would show the same steadfastness and discipline that Germany had appeared to show in its post-war stewardship of the D-mark.
Whether in diesel cars or the money supply, trust is a valuable commodity. If a nation like Germany is held in high esteem in a certain field, and that trust is eroded for any reason, then the effects can be far more harmful than slippages in countries not normally thought to adhere to high standards.
Just before monetary union started in 1999, Theo Waigel, the then German finance minister, stood accused of failing to adhere to the Maastricht convergence target that he himself had helped to formulate, of a budget deficit of 3% of GDP. This gave extra leeway to counties like Italy that were themselves struggling, with all kinds of somewhat unorthodox measures, to meet the criteria for joining the euro.
A few years later Hans Eichel, finance minister under Chancellor Gerhard Schröder, exceeded the 3% deficit target in the ‘stability and growth pact’ to give the German economy extra slack during the sluggishness of the early 2000s. The decision, gleefully backed by the European Commission and followed, too, by France, resulted in only a small overshooting – but the symbolic damage was great. Jean-Claude Trichet, the then European Central Bank president, still blames the Germans for fatally undermining budgetary discipline throughout the euro area – a somewhat overdone charge, but one that has stuck.
The implications this time are still more serious. German-style rigour is on the retreat everywhere in the euro area. Wolfgang Schäuble, the finance minister, cuts a lonely figure in European councils. If the Germans disregard their own rules in environmental technology, other people are not likely to heed Germanic strictures in economics.
Goodhart’s law says that any rule propounded as a target will cease to have meaning. Germany seems to have taken this one step further by saying that these rules are anyway solely for other people. I predict that, in forthcoming discussions about austerity throughout Europe, heads of government and finance ministers will find themselves talking, however improbably, about diesel emissions.
On 29 September OMFIF is publishing a report on ‘The future of the European Central Bank’ featuring contributions from the past six years of OMFIF Bulletins, including from (titles refer to positions held at time article appeared):
Franco Bassanini, Chairman, Cassa Depositi e Prestiti ; Marek Belka, President, National Bank of Poland; Lorenzo Bini Smaghi, Member, Executive Board, European Central Bank; Laurens Jan Brinkhorst, former Minister of Economic Affairs, Netherlands; Jacques Delors, former President, European Commission ; José Manuel González-Páramo, former Member, Executive Board, European Central Bank; Patrick Honohan, Governor, Central Bank of Ireland; Otmar Issing, former Member, Executive Board, European Central Bank; Jacques de Larosière, former Governor, Banque de France; Luis M. Linde, Governor, Banco de España; Gill Marcus, Governor, South African Reserve Bank; Yves Mersch, Governor, Banque centrale du Luxembourg; Christian Noyer, Governor, Banque de France; Peter Praet, Member, Executive Board, European Central Bank; Wolfgang Schäuble, Minister of Finance, Germany; Gerhard Schröder, former German Chancellor; Niels Thygesen, former Member, Delors Committee; Jens Weidmann, President, Deutsche Bundesbank.
For information on obtaining a copy of this report (free of charge) please e-mail email@example.com
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