Monetary Theory of Germany - Research Paper Example

Monetary Theory of Germany There has been a significant change over the past two decades in Germany’s monetary system. The introduction of the Euro currency in 1999 was a vital change in the country’s monetary system. Its use as cash money beginning in 2002 saw the old national currency lose its payment function with its exchange rate at the time being 1.96;1, at which it still stands. The DM is still convertible to date with billions of DM still in circulation. The German people were apprehensive at the beginning of losing the stable DM and acquiring a currency that had high inflation rates. This skepticism has gradually disappeared, and the currency has come to be viewed as stable. The financial crisis of 2008, however, led to a questioning of the stability of the Euro as a stable monetary system. The situation has worsened in recent years, and the future in Germany as far as the Euro is concerned has become uncertain. Introducing a new currency to remedy the economic situation is something that experts are still unable to agree. More Germans are now asking the DM to return and are unwilling to pay for the debts incurred by other EU countries. Various experts have warned that a return of the Deutsche Mark would result in a sharp drop where the German economy is concerned. Exports would fall coupled to a sharp fall in the countries GDP. Overall, Germany would be faced with a heavy financial burden if this were to happen. However, the costs of remaining in the EU could also increase to prior unseen heights. The decision that the Bundesbank and the German government take concerning the future of Germany in the Euro zone will have a big impact on the future of the German economy, whichever decision they decide on. Profile of the Bundesbank The Bundesbank act of 1957 birthed the central bank of Germany. In the period since, the independent Bundesbank has been successful in pursuing price stability. In fact, the ECB and other central banks in the EU transition economies have been modeled after it. The Bundesbank, by any definition of targeting, cannot be defined as a monetary targeter (Haan 67). Instead, it consciously uses its monetary targets as a signaling framework for intent and explaining its policies to the public. This has given the monetary stance taken by the bank an increased level of transparency, which has, in turn, enhanced its flexibility when it comes to economic responses such as the reunification process. Another step that the bank has taken to its benefit has been its independence from control by political events. The Bundesbank has taken transparency in a meaningful manner and has announced, publicly, its medium term policy goal of a 2% inflation rate and given information regarding its economic outcomes and policies that are necessary assessing the bank’s performance (Haan 70). Its steps towards this direction have proven that accountability to the standard that is clear helps rather than stands in the way of central bank independence in the long term. The highest form of praise for the successful steps taken by the Bundesbank over the past years has been imitation by other central banks. This has especially been so because of its independence from political control, legal statement that commits itself to price stability, and monetary target adoption (Haan 70). The Bundesbank is not a monetary targeter. However, this does not imply that inflation in Germany has stayed low due to factors beyond the bank’s control or luck. Historical records, as well as those from the past five years, have shown a different utilization of monetary targets. It uses the targets as a signaling framework. On top of increased transparency, the Bundesbank has taken to disciplined discretion (Haan 70). This is neither a complicated hidden law followed by the Bundesbank or the occurrences that follow when conservative central banks possess autonomy. It means that the bank has committed itself in publicly clarifying the stance and intent of its monetary policy regarding its announced goals on a regular basis, as well as its freedom to set policy as long as the commitments are satisfied. The bank has proven that, with monetary targeting, it is unnecessary to bind banks using specified rules, gold standards, and fixed exchange rates to retain a low rate of inflation. However, it is crucial that the bank sought to achieve transparency first via structured accountability and goal statement in relation to meeting its goals. The most important lesson that we can learn from the Bundesbank is that low inflation and flexibility for central banks are not necessarily in conflict (Haan 72). Banking Sector and major Players The German banking sector includes approximately 2,400 banks that have over forty five thousand branches across the country. Approximately four hundred of these are small banks with balance sheets, not in excess of 100 million Euros (Dietrich 39). German banks can be divided into two, specialized and universal banks. Specialized banks provide a limited amount of specified services and mainly give financial advice to businesses. They include special purpose banks, capital investment banks, building societies, and mortgage banks. The most distinguished of these types of banks include landwirtschaftliche Rentenbank, DWS Investment GmbH, and Deutsche Ausgleichsbank. The more common type is the universal banks that are responsible for approximately 75% of transactions that are done in the German banking sector (Dietrich 40). The financial services offered are more in number, as well as more varied, than specialized banks. Universal banks include private commercial banks that offer standard services of banking like provision of savings and checking accounts, payment processing, money lending to clients, bond underwriting, among others. Some popular commercial banks in Germany include Commerzbank AG and Deutsche Bank that are the largest, as well as Postbank, Landesbank Berlin holding, and Dresdner bank (Dietrich 40). Another type of universal bank in Germany is savings banks, also known as Sparkassen, whose main aim is to maintain client savings accounts. The deposits in this bank are protected by deposit insurance funds that are agreed on by the financial group of German savings banks. Finally, there are the credit cooperatives that promote their member’s economic advancement via execution of joint business ventures. Prominent banks in this category are WGZ-Bank and DZ Bank AG. Interest rates and Movements in the Last 3-% Years The German benchmark interest rate was recorded last at 0.75%. German interest rates averaged 2.6% from 2007 to 2012 reaching a high of 4.8% in October of 2008, and a low of 0.8% in the year 2012 (Sidney & Richard 58). Germany is a Euro zone member that has adopted the Euro. The benchmark for the Euro zone interest rates is at 1%. The decisions for the Euro zone interest rates are taken by the ECB’s Governing council, whose main objective is the maintenance of stability in price. This council has defined stability of price as a yearly increase in HCIP for the Euro zone below 2%. This translates into it being a monetary base monopoly supplier. Because of this monopoly, it has the capacity to set conditions for trade between banks in the monetary markets. In the short term, changes in interest rates for the money markets brought by the ECB sets a number of actions and mechanisms into action via economic agents (Sidney & Richard 59). In the end, the change is expected to influence economic variable developments, for instance, prices or input. The graph below gives a historical view of interest rates in Germany. (Sidney & Richard 60) Key Industries and Economic sectors In the Euro zone, Germany is the largest national economy. By nominal GDP, it is the 4th largest internationally while being the 5th by PPP (Stefan & Conny 22). Since the industrialization age, Germany has been a big beneficiary of the increasingly global nature of business, as well as being an innovator and driver of this economy. It is the 3rd largest exporter in the world with exports totaling 1.4 trillion dollars in the year 2011. These exports account for over a third of the country’s output nationally. The country is poor in natural resources with only potash and lignite being available in economically viable amounts (Stefan & Conny 22). Power plants that use lignite are the main electric source with natural gas, oil, and other resources being imported. The country has to import over two thirds of its total energy needs. The service industry in Germany accounts for approximately sixty percent of its total GDP, with agriculture accounting for 0.9%, and industry accounting for 29.1% (Stefan & Conny 24). Most products in Germany emanate from engineering with special emphasis on chemicals, metals, machinery, and automobiles. Germany is the world’s leading producer in solar and wind energy. The country also plays host to the world’s largest congresses, as well as trade fairs in various cities including Berlin, Frankfurt, and Hannover. A combination of SME, international cooperation, links between academia and industry, R&D spending, as well as service industries contribute to Germany’s overall competitiveness (Stefan & Conny 24). Thirty-seven of the 500 biggest listed companies by revenue have their headquarters in Germany. Of these, top ten in Germany are BMW, BASF, Munich Re, Deutsche Telekom, Metro, Siemens, Daimler, E.ON, Allianz, and Volkswagen. Other companies include Hugo Boss, Deutsche Post, Henkel, Infineon, SAP, Edeka, Commerzbank, Puma and Adidas, Merck and Bayer, MAN, and Robert Bosch. Key Economic Indicators for the last Five years GDP Actual GDP for Germany stands at 0.25 from a previous level of 0.3%. The country’s GDP increased by 0.2% during the 3rd quarter that was preceded by a 0.3% increase in the 2nd quarter (Moody's Analytics 1). Fixed investments, exports, as well as government and household consumption, increased on a quarter-by-quarter basis. (Moody's Analytics 1) Employment Situation The unemployment rate, seasonally adjusted, in Germany stayed steady at 6.9% for the month of December. The unemployed increased by 3,000, reaching 2.492 million. German PMI gauge for manufacturing fell from 46.8 to 46, indicating a weakening of the country’s economic performance in the coming months. This is expected to prevent firms from hiring more workers. (Moody's Analytics 1) Industrial Production This increased by a lower margin to what was expected. Weakening demand from foreign countries is expected to reduce production of capital and consumption goods. (Moody's Analytics 1) Foreign Trade Trade surplus fell from 14.9 billion Euros in October to 14.% billion in November. The sovereign debt crisis is expected to portend a modest effect on Germany in the current year. (Moody's Analytics 1) Tax Regime The tax system in Germany has undergone reform comprehensively from 2008. In principle, this was intended to ease tax rate for companies and individuals. Individual taxation of income in Germany is progressive. This means that tax payable increases with higher income. The tax rates for individuals in 2012 stand at 14%-45%. On income above 501,462 EUR for couples and 501,462 for singles, an income tax of 45% is paid before 8-9% church tax and 5.5% solidarity tax (Ault & Brian 45). On top of regular tax, a 14%-17% municipal trade tax is paid to the municipality. For corporate tax, there is a 15% corporate federal tax rate in Germany. In addition, a 14%-17% business tax is paid to the municipal council. Investment Inflow and Outflow A net outflow of foreign direct investments in Germany, as a percentage of GDP, was 3.305 in 2010. The highest value reached in the past ten years was 5.17 in the year 2008 while its lowest value was in 2003 at 0.21. The latest FDI value in Germany stood at approximately $62.2 billion by the year 2010 (Peng 33). The indicator’s value has fluctuated between approximately 150.341 billion in 2005 and $91.142 in the year 2010. The net inflows of foreign direct investments as a percentage of the GDP for Germany stood at 1.41 in the year 2010 with the highest value being in 2000 at 11.14 and the lowest being in 2004 at -0.36 (Peng 34). The latest net inflow FDI value in Germany in 2010 was at $46.127 billion with the value fluctuating between $9.802 in 2004 and $210.085 billion in 2000. Major Investing Sectors The most important sectors in Germany for investment are chemicals, electrical engineering, mechanical engineering, and automotive manufacture. The innovative engine room in Germany is the automotive industry with approximately 30% of all R&D Company spending occurs in this sector (Owen 59). Alongside the US, Japan, and China, the six manufacturers in Opel, Porsche, Daimler, BMW, Audi, and VW from Germany have a substantive market in the luxury and upper mid-range segments. Current trends in this sector are now looking towards new diesel engine generations, power trains, and hybrid vehicles. Mechanical engineering companies place at second with the electronics industry taking up 20% of all R&D investment in the economy (Owen 61). In addition, Germany also boasts the largest chemical plant company in the world in BASF. The service sector employs over 12 million people in transport, hospitality, and commerce while 7 million are involved in the corporate, leasing, and financing. Insurance and banking act as the service sector’s main pillars. Foreign exchange Reserves The German central bank has foreign exchange reserves of $238.9 billion and gold reserves of $216.5 billion (Donald et al 23). This gives the value in dollars for all financial assets available to the Bundesbank for use in meeting the balance of payments for the country needed to for the end-date period given. It includes gold reserves, foreign currency, and holdings of IMF special drawing rights, in addition to the fund’s reserve position. Economic Cycle Since the end of 2011, the threat of recession has significantly receded in Germany. Thanks to benign conditions in the domestic market, the economy grew in the first quarter of 2012. However, the German economy continues to face headwinds due to Euro zone turmoil and slow growth internationally has heavily affected the export market. The slowdown of the manufacturing industry has signified weakening economic conditions. The mixed conditions of the economy now being witnessed put Germany in the mid to late expansion phase of the economic cycle (Soto et al 22). Works Cited Ault, Hugh. & Brian, Arnold. Comparative income taxation a structural analysis. Austin : Wolters Kluwer Law & Business, 2012. Print. Dietrich, Benjamin. German banking structure, pricing and competition : implications and international policy perspectives. Frankfurt : Peter Lang, 2009. Print. Donald, Mathieson.& Barry, Eichengreen. The Currency Composition of Foreign Exchange Reserves - Retrospect and Prospect. Washington: International Monetary Fund, 2012. Print. Haan, Jakob. History of the Bundesbank. London: Routledge, 2012. Print. Moody's Analytics. Germany: Key Indicators in Brief. 2012. Web 14 January 2012 www.economy.com/dismal/outlook/country.aspx?geo=IDEU>. Owen-Smith, E. The German Economy. London: Routledge, 2012. Print. Peng, Mike. Global business. Mason : Cengage South Western, 2011. Print. Sidney, Homer. & Richard, Sylla. A History of Interest Rates. Hoboken: John Wiley & Sons, 2011. Print. Soto, Jesu?s Huerta de and Melinda A Stroup. Money, bank credit, and economic cycles. Auburn : Ludwig von Mises Institute, 2012. Print. Stefan, Henn. & Conny, Grabner. The Meeting Industry in Germany - Development and recent Trends:. Santa Cruz: GRIN Verlag, 2012. Print. Read More