Bundesbank under fire on interest rate policy

UNLESS the Bundesbank initiates a clear and sharp reduction in interest rates there is little prospect of predictions of even modest German growth next year being fulfilled, the country's five leading economic institutes say.

In their joint annual autumn report they launched an unusually harsh attack on the Bundesbank's unnecessarily restrictive interest rates, intimating that they had contributed to the German economy's 'critical situation'.

While most of the institutes wanted to describe the economy as already in recession, objections by some over definition led to agreement on a 'marked economic downturn'.

The institutes forecast real growth of 0.5 per cent in western Germany next year. A weak recovery in the east will bring aggregate growth up to 1 per cent.

Heiner Flassbeck, head of the German Economic Institute in Berlin, said the realisation of such predictions depended crucially on three main conditions - a recovery in the international economy, wage settlements below the expected western German inflation rate of 3.5 per cent and 'very strong cuts' in short-term rates combined with 'clear reductions' in long-term rates.

Referring to discussion about raising taxes to pay for unification the institutes said that, in the light of the weakened state of the economy, the priority should be on cutting subsidies in the west.

Mr Flassbeck criticised the Bundesbank for having persisted with record high interest rates based on an erroneous calculation of M3 monetary growth. If the necessarily strong inflation in eastern Germany, brought about by ending price controls, had been adequately taken into account, the M3 growth corridor on which the bank based its interest rate policy should have been 7 per cent this year and not 4.5 per cent.

'For some time, doubts have been growing as to whether the strong expansion in the money supply really reflected a destabilising, expansionary monetary policy,' the report continued.

Mr Flassbeck said that for 1993 the M3 growth corridor should be set around a 7 per cent average, which would pave the way for quick rate cuts. Such cuts were needed if 'the real danger hanging over the German economy is be avoided' - that the already faltering investments by western German firms in the east would grind to a halt.

The institutes' report also dealt harshly with the trade unions, saying that if they had not pushed so aggressively for high wage rises the economic situation in Germany 'would today be rather different'. It was essential, Mr Flassbeck said, that in the 1993 wage round the unions accepted increases averaging 3 per cent in western Germany.

In the east the institutes want a 'clean break' with the system of automatically raising wages to western levels, which has led to many firms there 'having no hope of finding a place in western markets'. Instead, wage increases must be linked to productivity, which remains low.

The institutes expressed concern that the government's new willingness to accept tax increases to meet the rising costs of unification would undermine the pressure for cuts and savings in the west.