1. Home
  2. Studies
  3. Money supply and inflation in Europe: Is there still a connection?
Matthias Diermeier / Henry Goecke IW-Policy Paper No. 17 21. December 2016 Money supply and inflation in Europe: Is there still a connection?

Since the outbreak of the European financial and economic crisis in 2008, the monetary policy of the European Central Bank (ECB) has been in crisis mode. Ensuring that the growth in the money supply transmutes into higher inflation or inflation expectations has been difficult.

Download PDF
Is there still a connection?
Matthias Diermeier / Henry Goecke IW-Policy Paper No. 17 21. December 2016

Money supply and inflation in Europe: Is there still a connection?

IW policy paper

Download PDF

Share this article:

or copy the following link:

The link was added to your clipboard!

German Economic Institute (IW) German Economic Institute (IW)

Since the outbreak of the European financial and economic crisis in 2008, the monetary policy of the European Central Bank (ECB) has been in crisis mode. Ensuring that the growth in the money supply transmutes into higher inflation or inflation expectations has been difficult.

The central bankers are attempting to get a grasp on the current low inflation rates and inflation expectations by, among other things, introducing a policy of extreme quantitative easing. The expansion of the Eurosystem's balance sheet was problem-free on this occasion, and the ECB also managed to eventually increase the money supply again. However, ensuring that the growth in the money supply transmutes into higher inflation or inflation expectations has been much more difficult.

Results of the empirical assessment

  • The formulation of an appropriate monetary policy for the heterogeneous country groups of the euro area remains a challenge.
  • Controlling the money supply is now the last option remaining out of three monetary policy instruments.
  • Monetary developments have become disconnected from inflation developments. At present a structural break exists for the various euro area countries.
  • The ECB's asset purchase programme and the accompanying shift from long-term to short-term assets on banks’ balance sheets is partly responsible for this development.
  • In the current regime of extremely low interest rates, there is a strong connection between the liabilities and lending of commercial banks and inflation for individual countries.
  • Two problems stand in the way of a universally effective monetary policy in the euro area: real economy divergence and the different ways in which financial intermediation works in the different countries.

Recommendations

  • Monetary policy must focus on boosting private demand through increased lending in order to achieve the inflation target.
  • On the demand side, a reduction in the general and political uncertainty is necessary, while on the supply side, critical reflection on the regulatory guidelines is required.
  • In order for monetary policy to once again be effective in all euro area countries, the banks must be able to fulfil their roles properly. A clean-up of banks’ balance sheets and the write-off of non-performing loans are desperately needed.
  • Recommendations 2 and 3 cannot be resolved through monetary policy. The governments of the respective Member States must take action. These must raise the employment intensity of growth and push ahead with the regulatory and supervisory clean-up of banks’ balance sheets.
Download PDF
Is there still a connection?
Matthias Diermeier / Henry Goecke IW-Policy Paper No. 17 21. December 2016

Matthias Diermeier / Henry Goecke: Money supply and inflation in Europe – Is there still a connection?

IW policy paper

Download PDF

German Economic Institute (IW) German Economic Institute (IW)

Share this article:

or copy the following link:

The link was added to your clipboard!

More on the topic

Read the article
Hubertus Bardt / Klaus-Heiner Röhl / Christian Rusche in The Economists' Voice External Publication 21. June 2022

Subsidizing Semiconductor Production for a Strategically Autonomous European Union?

The COVID-19 pandemic has highlighted the vulnerability of international supply chains and the dependency of the economy of the European Union (EU) on goods from non-EU countries. The scarcity of microchips that has persisted since the COVID lockdowns has laid ...

IW

Read the article
Sandra Parthie Event 15. June 2022

Panel discussion: Basel implementation in challenging times – How to find the right balance?

There are plenty of challenges ahead of us, the transition to a digital and sustainable economy, dealing with the impacts of the pandemic and a staggering inflation. Also the ussian aggression against Ukraine has made a recalibration of our political and ...

IW

Content element with id 8880 Content element with id 9713