Opting out the great inflation: German monetary policy after the breakdown of Bretton Woods

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During the turbulent 1970s and 1980s, the Bundesbank built a stellar reputation in central banking, achieving domestic stability and becoming a safe haven for investors amid global financial turmoil. This period is significant in European monetary history, as the Bundesbank's approach ultimately served as a model for the European Central Bank. This paper explores how the Bundesbank's monetary policy strategy contributed to its success, analyzing the strategy's conception, communication, and refinement. We propose a theoretical framework, based on Söderström (2005), interpreting monetary targeting primarily as a commitment device that anchors inflation and inflation expectations. We derive an interest rate rule that empirically reflects the Bundesbank's policy from 1975 to 1998. A comparison with the monetary policy rules of the FED and the Bank of England reveals that the Bundesbank's reaction function exhibited strong persistence in policy rates and a robust response to inflation deviations from the target and activity growth gaps. However, the response to the output gap was not significant. Our empirical analysis utilizes real-time data available to policymakers during that era, focusing on key aspects such as inflation, price stability, and policy rules.