Is Frankfurt set for a great central bank showdown? If policymakers manage to strike a deal on a new “fiscal compact” at this week’s summit, the president of the European Central Bank, Mario Draghi, has signalled he could escalate the bank’s response to the eurozone debt crisis.
Yet across town, Jens Weidmann, the president of Germany’s famously conservative Bundesbank, has argued vehemently that expanded government bond purchases are not the answer to the region’s woes - and may make them worse.
Past experience might suggest the conflict will not be resolved without significant collateral damage.
When the ECB’s bond buying programme was first launched in May 2010, Mr Weidmann’s predecessor, Axel Weber, was strongly opposed. His publicly-voiced concerns about what he saw as a dangerous blurring of fiscal and monetary policies left him isolated on the ECB’s 23-strong governing council.
In February this year Mr. Weber finally quit as Bundesbank president, in the process dashing Berlin’s hopes of installing him (and not Italy’s Mr Draghi) as the ECB’s head.
On one view, Mr. Weidmann has boxed himself even more into a corner. The youthful Bundesbank president, 43, warns against the ECB straying beyond its primary job of combating inflation. He has pointed repeatedly to the ban on “monetary financing” - central bank funding of governments - that is written into European treaties. “I don’t see how you can build trust in a system that violates laws,” Mr. Weidmann told the Financial Times last month.
“Weidmann has to stick to his principles,” says one German ECB watcher. “I don’t think he can say it was all a terrible misunderstanding. If the ECB comes up with a plan for more aggressive bond buying, he will have to resist.” Those familiar with ECB discussions say Mr. Weber, a former academic economist, was at least easier to engage in an intellectual argument.
But Mr Weidmann may not be on an inevitable collision course with Mr Draghi. A former economics adviser to Angela Merkel, the German chancellor, he has a better political feel than Mr. Weber, whose relationship with Jean-Claude Trichet, former ECB president, was tetchy. Whereas Mr. Weber opposed bond purchases in a German newspaper interview within hours of the programme’s launch, his successor has been loyal in public. Mr. Weidmann has also sought allies within the ECB council.
“The new Bundesbank president could not simply continue with the same policies and style as his predecessor - otherwise he would eventually have had to go. He had to change something,” says Jörg Krämer, chief economist at Commerzbank in Frankfurt. “What has changed is the style - which is different from the more aggressive style of his predecessor. But that is all that has changed.”
Arguably, a more emollient Mr Weidmann could allow the ECB to expand bond buying without provoking an outright clash with the Bundesbank - especially if it was not explicit about its intentions. Some familiar with his thinking believe Mr Weidmann would also react flexibly if plans were agreed to boost International Monetary Fund resources so the Washington-based institution could, in turn, increase its help for the euro zone.
But another reason a conflict could be avoided is that Mr Weidmann’s thinking is not so different from Mr. Draghi’s. Worries have grown at the ECB that past bond purchasing has simply delayed action by governments. Silvio Berlusconi’s departure last month as Italy’s prime minister has strengthened a feeling that the ECB is right to take a tough line.
“A clash is potentially there, but it could be more apparent than real because I think that, ultimately, [the ECB]will do whatever they have to do in a very steely way and veer more towards the Bundesbank conservatism than is popularly supposed,” said David Marsh, co-chairman of the Omfif think-tank and a Bundesbank expert. “It is not because of some antique German fetish but because this is the right way to make governments live up to their responsibilities.”
That could mean the ECB’s response to the crisis falls short of financial markets’ expectations. The alternative, however, would be to press ahead with bolder action - and risk markets testing if a divided ECB can really stick to its guns.