The key chart
The key message
Broad money (M3) in the euro area (EA) is growing at its fastest rate since early 2008. However, CMMP analysis of the components and counterparts of this growth suggests that the associated “messages from the money sector” and their implications are very different.
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. In contrast, the current message is one of heightened uncertainty and subdued credit demand. Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary).
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Seven charts that matter
Broad money (M3) in the euro area (EA) is growing at the fastest rate since early 2008. M3 grew 10.4% YoY in September, up from 9.5% in August. This is the fastest rate of YoY growth since April 2008 when M3 grew 10.6% YoY. However, CMMP analysis of the components and counterparts of these two growth phases suggests that the associated “messages from the money sector” are very different. Current trends are not a repeat of 2008 dynamics.
Note that the components and counterparts of M3 provide different perspectives and explanations of changes in broad money. Monetary aggregates are derived from the consolidated monetary financial institutions (MFI) balance sheet and comprise monetary liabilities of MFIs and central government vis-à-vis non-MFI euro area residents.
The Eurosystem defines narrow (M1), intermediate (M2) and broad (M3) aggregates. They differ with respect the degree on “moneyness” or liquidity of the instruments included. M1, for example, comprises only currency in circulation and balances that can be converted into currency or used for cashless payments. Relative high holdings of M1 indicate a relatively high preference for liquidity and can be used as an inverse proxy for the level of private sector confidence.
The consolidated MFI balance sheet also provides the basis for analysing the counterpart of M3. All items other than M3 on the consolidated balance sheet can be rearranged to explain changes in broad money. The relationship between M3 and its counterparts rests on a simple accounting identity. What this means is that we have two identities that can be used to provide different perspectives on changes in broad money:
- Components: Broad money equals M1 plus M2-M1 plus M3-M2
- Counterparts: Broad money equals credit to EA residents plus net external assets minus longer term financial liabilities plus other counterparts (net)
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. From a components perspective, for example, M1 was growing only 2.7% YoY in April 2008 and contributing just 1.2ppt to the overall 10.6% growth in total money. At this point M1 accounted for 43% of the outstanding stock of money. From a counterparts perspective, private sector credit was growing at 11.2% and contributing 17.6ppt to the growth in total money (offset by negative contributions from net external assets and LT financial liabilities). Credit to general government was contributing just 0.1ppt to broad money growth.
In contrast, the current message is one of heightened uncertainty and subdued credit demand. M1 grew 13.8% YoY in September 2020, up from 13.2% in August and contributed 9.4ppt to the overall 10.4% growth in broad money (versus 9.0ppt in August). M1 now accounts for 70% of the outstanding stock of money. The private sector is holding higher levels of the most liquid assets despite negative real returns on those instruments. This suggests high levels of uncertainty that have been exacerbated by the Covid-19 pandemic. (Note in passing that monthly flows showed a divergence between rising and above 2019-average household deposit flows and falling and below 2019-average NFC flows in September).
Private sector credit grew 4.6% YoY in September, unchanged from August. As before, relatively robust demand for NFC credit (7.1%) and resilient (and rising) mortgage demand (4.5%) continue to offset relative weakness in consumer credit (0.1%). However, private sector credit contributed only 5.2ppt to the overall 10.4% growth in broad money.
A key point here is that, in typical cycles, monetary aggregates and their counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing. The current relationship between money and credit cycles is far from typical, however. Indeed the gap between M3 and PSC is at a historic high reflecting the fact that the euro area is only emerging very gradually from a period of debt overhang.
Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary). Credit to general government and credit to the private sector contributed 6.8ppt and 5.2ppt respectively to the 10.4% growth in broad money (see graph above). This is in direct contrast to the pre-GFC period when money expansion was driven primarily by strong, or excess, private sector credit demand (see graph below).
Conclusion – don’t confuse the messages
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.