David Marsh: Volkswagen Scandal Hurts the German Government's Hard-Won Credibility

2015-09-28 IMI

The Official Monetary and Financial Institutions Forum (OMFIF) is a global financial think tank headquartered in London. David Marsh: Managing Director, Official Monetary and Financial Institutions Forum (OMFIF) Professor Charles Goodhart, the distinguished British economist and former member of the Bank of England’s monetary-policy committee, and Volkswagen, the German car maker, were born within a few months of each other, in October 1936 and May 1937, respectively. You might expect the similarities to end there. But there’s more to it than that. Our good and previously distinguished friends at Volkswagen AG VOW, -0.72% have just demonstrated — in a striking way that is reverberating around Europe and changing the climate for the euro’s future — the fundamental truth of a ‘”law” that Goodhart formulated about 40 years ago: “Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” In other words, when the authorities start to measure some kind of variable and use it as a barometer of policy and performance, the parameter ceases to hold meaning. Once a measure becomes a target, it loses its validity, as VW VLKAY, -1.66% in breath-taking manner, has shown with its clinical use of engineering and software to sidestep controls on harmful emissions. The VW affair has large repercussions for the monetary union because, in this matter of truth, trust and statistics, we have been here before. Put simply, with some strong-arming from friends like President François Mitterrand, Germany agreed to give up its currency after unification in 1990 on the condition that its partners around Europe would show the same degree of steadfastness and discipline that Germany showed in its post-war stewardship of the deutsche mark. Trust is a valuable commodity. If a country like Germany is held in high esteem in a certain field — whether in environmental technology or in fiscal and monetary control — and that trust is eroded for any reason, the effects can be far more harmful than slippages in countries not normally thought to adhere to high standards. Just before the monetary union started in 1999, Theo Waigel, then the German finance minister, stood accused of failing to adhere to the Maastricht convergence target of a budget deficit of 3% of GDP. This gave some leeway to countries like Italy that were themselves struggling to meet the criteria for including their currencies in the euro. We saw another case a few years later when Hans Eichel, finance minister under Chancellor Gerhard Schröder, deliberately exceeded the 3% deficit target in the “stability and growth pact” to give the German economy extra slack during the sluggishness of the early 2000s. The decision, gleefully backed by the European Commission and followed by France, resulted in only a small overshooting. But the symbolic damage was great. Former European Central Bank President Jean-Claude Trichet still blames the Germans for fatally undermining budgetary discipline throughout the euro area. This is a somewhat overdone charge, but one that has stuck. The implications this time are still greater. German-style rigor is on the retreat everywhere in the euro area. Wolfgang Schäuble, the finance minister, cuts a lonely figure in European councils. If the Germans disobey their own rules in diesel emissions, other people are not likely to heed Germanic strictures in the economic field. Goodhart’s law says that any rule propounded as a target will cease to have meaning. Germany seems to have taken this one step further by saying that these rules are solely for other people. During forthcoming discussions about austerity throughout Europe, heads of government and finance ministers will find themselves talking, however improbably, about diesel emissions.

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David Marsh: Volkswagen Scandal Hurts the German Government's Hard-Won Credibility

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