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Why The Bundesbank Is In A Bind

International Business Outlook


Is overly rapid growth in Germany's M3 money supply a problem for the inflation outlook or not? That depends on which Bundesbank official you listen to.

Until recently, the Buba's standard line was that the broad M3 measure was exaggerated by temporary influences, including 1993 changes in tax policy. But after the April data, showing that M3 grew at a faster-than-expected 15.8% annual rate, up slightly from March's pace and far beyond its 4%-to-6% target range, Bundesbank Council Member Reimut Jochimsen became the first Buba official to publicly challenge that notion.

Jochimsen's remarks, after the data were released on May 24, ignited inflation fears, sending stock-and-bond prices plummeting throughout Europe and raising speculation that further cuts in official interest rates are on hold. Other Buba officials have since echoed the M3 concern, and on June 1, council member Guntram Palm opined that rates have now reached "at least a holding point if not a turning point."

Clearly, the near-term inflation outlook is excellent. May's preliminary cost-of-living index for western Germany rose only 2.9% from a year ago (chart), and readings will go lower, given weak domestic demand and falling wage growth.

But the new inflation fears go beyond 1995, especially with European economies on the mend while price worries in the U.S. are already growing. The German bond market was so petrified after Jochimsen's comments that the Bundesbank had to withdraw the Finance Ministry's auction of four-year notes for lack of demand--the first failed auction since 1990, followed by another cancellation of a long-bond auction on May 31.

That's probably an overreaction. Many Buba officials believe that M3 will slow as lower short-term rates cause funds to shift out of M3 into longer-term investments. And central bank President Hans Tietmeyer has said that the rate on securities repurchase agreements, the Buba-set anchor for money-market rates, can fall further.

Indeed, the bank shaved the repo rate to 5.15% on June 1, from 5.20%. The rate moves within the corridor set by official rates--currently a 4.5% discount rate and a 6% Lombard rate, both last lowered by a half-point on May 13. But now, with attention back on M3, its failure to slow could tie the Bundesbank's hands indefinitely.JAMES C. COOPER AND KATHLEEN MADIGAN

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