Opting out of the great inflation:German monetary policy afterthe breakdown of Bretton Woods

During the turbulent 1970s and 1980s the Bundesbank established an outstandingreputation in the world of central banking. Germany achieved a high degree of domesticstability and provided safe haven for investors in times of turmoil in the internationalfinancial system. Eventually the Bundesbank provided the role model for the EuropeanCentral Bank. Hence, we examine an episode of lasting importance in Europeanmonetary history. The purpose of this paper is to highlight how the Bundesbankmonetary policy strategy contributed to this success. We analyze the strategy as it wasconceived, communicated and refined by the Bundesbank itself. We propose atheoretical framework (following Söderström, 2005) where monetary targeting isinterpreted, first and foremost, as a commitment device. In our setting, a monetarytarget helps anchoring inflation and inflation expectations. We derive an interest raterule and show empirically that it approximates the way the Bundesbank conductedmonetary policy over the period 1975-1998. We compare the Bundesbank's monetarypolicy rule with those of the FED and of the Bank of England. We find that theBundesbank's policy reaction function was characterized by strong persistence of policyrates as well as a strong response to deviations of inflation from target and to theactivity growth gap. In contrast, the response to the level of the output gap was notsignificant. In our empirical analysis we use real-time data, as available to policymakersat the time.[...] Andreas Beyer, Vitor Gaspar, Christina Gerberding, Otmar Issing