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Feb 12, 2011 | 14:46 GMT

6 mins read

Germany's Central Bank Chief and the Future of the ECB

MICHAEL GOTTSCHALK/AFP/Getty Images
Summary
Axel Weber, the president of Germany's central bank, will step down from his position April 30, according to a German government spokesman. Weber, an inflation hawk, had been Berlin's favorite candidate for the presidency of the European Central Bank (ECB). However, a shift in Germany's attitude toward the eurozone economic crisis led to a split with Weber. This means the race for ECB leadership is wide open, and could result in an ECB whose policies are more accommodative than Weber would have liked.
Axel Weber, head of Germany's central bank (the Bundesbank), will step down April 30, government spokesman Steffen Seibert said Feb. 11. According to Seibert, Weber cited personal reasons for his decision following a meeting with German Chancellor Angela Merkel and German Finance Minister Wolfgang Schaeuble. The decision to step down as Bundesbank president likely takes Weber out of the running for the presidency of the European Central Bank (ECB), for which he was pegged as the leading candidate to succeed Jean-Claude Trichet when his mandate ends Oct. 31. Weber's resignation throws the race for the ECB presidency wide open. The ultimate decision for the eurozone is whether to go with a strict inflation hawk opposed to intervening on behalf of embattled peripheral eurozone states, like Weber, or a softer, more dovish alternative. The two choices mean the difference between an accommodative ECB willing to fudge the bank's mandate to support peripheral European economies though at the risk of reducing incentives to stick to fiscal austerity, and a firm ECB reaffirming the need for painful austerity but with the risk of complicating the eurozone's crisis further. Throughout the eurozone's sovereign debt crisis, the ECB has provided behind-the-scenes support that has calmed investor fears that the Continent was headed toward financial Armageddon. Before the Greek bailout last May, the ECB was providing European banks with unlimited loans against eligible collateral, mainly government bonds. This kept the banks capitalized and kept demand for bonds strong, thus helping to prevent Athens and other peripheral states' financing costs from rising substantially. The interactive graphic below shows how this worked. (click here to view interactive graphic) The problem was that credit rating agencies kept downgrading government bonds throughout the crisis, which threatened to push their rating below the ECB's threshold and thus make those bonds ineligible for ECB loans. But the ECB kept loosening the rules regarding the bond rating it would accept as collateral, preventing the complete collapse of interest in peripheral sovereign bonds and extending a lifeline to embattled governments and their banking sectors. This strategy was sufficient for a while, but after a series of unsettling developments in Greece and elsewhere, investors again began to lose confidence en masse, forcing the ECB to stem the sell-off by purchasing peripheral eurozone states' bonds in the secondary market, a very controversial move. Weber publicly opposed the decision, drawing ire not only from the most troubled eurozone economies but also from Merkel and other ECB Governing Council members. Weber had been Berlin's favored candidate for ECB chief. He is considered to be an inflation hawk committed to maintaining the eurozone's inflation of "above, but close to, 2 percent" (headline inflation in January was up 2.4 percent year-on-year) and opposed to the ECB's intervention in bond markets to support struggling eurozone states. As such, he would reassure the German populace the euro was in capable (i.e., German) hands. Merkel's policy of supporting fellow eurozone member states via bailouts has been criticized in Germany, particularly from her own constituencies on the center-right. Polls in Germany show that as much as 50 percent of the population would prefer a return to the deutsche mark over sticking with the euro. With seven state elections coming up in 2011, including four between Feb. 20 and late March, Merkel needed to reassure her electorate that Berlin would not allow the eurozone to be mismanaged or become the dreaded "transfer union" that the German media has accused the chancellor of creating. However, European media reports indicate that Weber did not want to go along with the plan. While Berlin wants eurozone states to enact austerity measures, and is forcing such a policy by threatening to withdraw bailout support, Berlin has also increasingly supported the ECB's bond purchase programs and relaxed its attitude toward higher inflation — the idea being that Berlin could push for tight fiscal reforms knowing that any fallout would be mitigated by an accommodative ECB. Weber was unwilling to be used as a reassurance for the German elections and then forced to push through unorthodox policy anyway, being largely outnumbered by Governing Council members who did not agree with his approach. The significance of the break between Weber and Merkel is now twofold. First, Merkel may be pressured domestically for her policy. Getting a German to head the ECB was seen as a central pillar of her policy to win back support from her fellow conservative Germans who have opposed bailouts and the setting up of the 440 billion euro ($596 billion) bailout fund, the European Financial Stability Facility (EFSF). There are still German alternatives in the running, starting with the EFSF head Klaus Regling, but none can quite fill the role as Weber could. Regling, after all, runs the bailout fund and does not have Weber's level of experience with monetary policy. Merkel may suffer a severe conservative revolt in the upcoming elections, especially in the March 27 elections in Baden-Wuerttemberg, traditionally a bastion for her Christian Democratic Union. Second, Europe faces the long-term question of what the repercussions of a clearly accommodative ECB would be. If peripheral states feel that the ECB will continue to contain market pressures by intervening in the bond markets, they may begin to pull back on the German-imposed austerity measures that are so unpopular with their constituencies. In other words, peripheral eurozone states could decide that they can ultimately win the game of chicken against the monetary authority and can therefore force the ECB to make concessions. The eurozone has been stabilized with an array of promised reforms, bailouts and German leadership. But if a central bank safety net undermines Berlin's attempts to reform the eurozone, and the notion of an ECB at the mercy of the peripherals' economic troubles presents problems for Merkel domestically, the eurozone could once again teeter on the edge of crisis.

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