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EU flags fly at the European Commission headquarters in Brussels in this file photo from 2011. (Yves Logghe/Associated Press)
EU flags fly at the European Commission headquarters in Brussels in this file photo from 2011. (Yves Logghe/Associated Press)

How the ECB is choking euro zone growth Add to ...

The euro zone has a number of issues, not the least of which is that it’s not an optimal currency area. At a minimum it requires true fiscal federalism and a banking union if it is going to survive and thrive. But we cannot overlook the drastic fall in the growth rate of the money supply over the past few years.

The monetarist school of thought makes a number of predictions when it comes to the money supply and economic growth. One of the most basic predictions of monetarism is that when the growth rate of the money supply falls, we should expect to see a reduction in economic activity along with a reduction in the rate of inflation. This is exactly what we are currently seeing in the euro zone.

There are a number of ways to measure the size of the money supply. Two of the most useful are M1, a narrow measure which includes currency, traveler’s cheques and demand deposits at banks. The other, M3, is a broad measure which includes all of the items in M1 as well as savings deposits, money-market accounts and other large liquid assets.

The annual growth rates of both M1 and M3 have fallen sharply in the euro zone, taking its economy along with it.

From September, 1998 (the first month where statistics are available) to the end of 2007, the M1 money supply grew at roughly 8.7 per cent a year in the euro zone. The growth rate of M1 was relatively stable from the middle of 2006 to November of 2007, hovering between 6 and 8 per cent a year. It then fell drastically, bottoming out at a 0.2 per cent annual growth rate in August, 2008.

After bottoming out, M1 growth rates rebounded as the European Central Bank provided liquidity to financial markets on Oct. 8, 2008. The rapid rise continued until mid-2009, hitting 13.3 per cent in August of that month. The ECB held firm on rates between mid-2009 and 2011, letting the growth rate of M1 fall steadily during this period. Despite falling to 3 per cent in March, 2011, the ECB inexplicably tightened monetary policy on April 7. The annual growth rate of M1 has averaged 1.8 per cent since the April, 2011, decision, a mere one-fifth of the 8.7 per cent 1998-2007 average.

The growth rate of the broader M3 measure shows a similar phenomenon but with a lag. Between 1998 and 2007, M3 grew at roughly 7 per cent per year. There was a steady but steep decline in the growth rate of M3 from October, 2007, to December, 2009, from a high of 12.4 per cent down to a low of –0.4 per cent. M3 growth rates then recovered somewhat, likely thanks to the 2009 increases in M1 (Changes in M3 lag changes in M1 by a considerable time frame).

In 2010 and 2011, it has hovered between a 0 to 3 per cent growth rate, averaging roughly1.5 per cent. This fall from 7 per cent to 1.5 per cent is roughly equivalent to the fall seen in M1 growth rates.

By allowing M1 and M3 growth to fall well below historical norms, the European Central Bank is largely responsible for the current euro zone economic slowdown.


Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University

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