Dissecting the Eurozone's (lack of) inflation

Eurozone inflation is in the doldrums again. After perking up to 1.7% in April, it slumped back to 1.2% in May. According to Bloomberg, this was "lower than expected". But I wonder who, apart from the ECB, really expected anything else. Core inflation has been well below target for the last five years:

(chart from Bloomberg)

And although the headine HICP measure increased in 2016-18, this was mostly due to the oil price bouncing back from its 2014-15 slump:

(chart from Macrotrends)

The wild swings in the energy inflation rate can be clearly seen on this chart from Eurostat:

It's perhaps not obvious at this resolution, but the movement in headline HICP is almost entirely due to the energy price.

In fact comparing the inflation and oil price charts, it is hard to see much justification for the ECB's claim that it started QE in March 2015 because inflation expectations were becoming "unanchored". Headline HICP briefly dipped below zero in January 2015 because of a temporary external shock. There was no reason to suppose this would result in general deflation. And the core inflation measure, which excludes oil, was roughly where it had been since 2013.

And it doesn't seem that QE had much effect on inflation, either. Whatever the ECB may think, it was principally oil prices, not QE, that lifted headline HICP to 2%. Now the oil price is on its way down again:

(chart from Hargreaves Lansdown)

Unsurprisingly, so is HICP. Meanwhile, core inflation - a better measure of the effectiveness of ECB monetary policy - has stayed stuck at around 1%. On this basis, it is hard not to conclude firstly that QE was ended prematurely, and secondly that the design of the ECB's QE programme left a lot to be desired. What on earth is the point of subsidising rich Eurozone governments to the tune of €billions if it doesn't bring core inflation up to target?

All measures of  inflation are remaining lower than expected for much longer than expected. I've previously discussed the disinflationary bias in ECB policy-making. Sadly, it doesn't seem that this is changing any time soon.

The ECB's favourite indicator of inflation expectations, the 5 year 5 year inflation-linked swap rate, has been trending downwards since late 2018 and has now slumped to 1.32, close to the level at which the ECB previously decided expectations were becoming "unanchored". Yet the ECB has done virtually nothing except repeat "monetary policy remains accommodative". Unsurprisingly, inflation is also falling. In response, the ECB has simply cut its inflation forecasts and muttered about "standing ready" to do something "when conditions dictate". It's amazing how unconcerned the ECB can be about its price stability mandate when inflation is below target, as it mostly is.

At its last meeting, the ECB repeated its "longer for lower" forward interest rate guidance, announced a new round of TLTROs (cheap loans to banks) starting in September, and floated the idea of tiered interest rates to protect banks from the profit-eating effects of negative interest rates. This was never going to be an adequate set of responses to an evident disinflationary trend. Unsurprisingly, markets were unimpressed. They want a bazooka, and they want it now.

To be sure, inflation expectations are something of a self-fulfilling prophecy: if people expect inflation to fall, it will fall. There might be an argument that doing nothing except reiterating the adequacy of existing policy settings stops the bears from feeding. But the 5 year 5 year curve is not the only indicator that economic conditions in the Eurozone are worsening.

The April edition of the ECB's Monetary Developments in the Eurozone bulletin contains some worrying statistics. Here's the growth rate of monetary aggregates M1 and M3:

The very high M1 growth rate between 2015 and 2017 is due to QE, and it inevitably tailed off when purchases ended in 2018. However, it is now beginning to tail off again after rising in the early part of this year. This suggests weaker bank lending, though this is not (yet) reflected in the ECB's adjusted lending figures.

Looking at M3 (broad money), it is evident that QE withdrawal was premature. Withdrawing QE should not cause M3 growth to drop significantly. If it does, it means that the economy is still operating below potential. The chart shows that M3 growth slowed significantly when the ECB started to taper off purchases.

The M3 growth rate has improved this year, but I fear this will not last. M3 growth lags M3 lending, and the growth rate of M3 lending (including securities and commercial paper) is already slowing. The ECB's commentary says that the growth rate of total credit to both the private and sectors has fallen. The figures in the annex show that this is driven mainly by a significant fall in the rate of debt security issuance by both the private and public sectors. As the M3 lending growth rate is a reasonably reliable measure of general economic activity, this does not bode well for the Eurozone economy.

Looking at the components of M3 reveals another vulnerability. This chart shows that growth in government borrowing has slowed to a crawl:

But offsetting this is an increase in net external financial assets. Meanwhile, domestic private credit growth is flat. Increasingly, Eurozone residents are investing outside the Eurozone. The Eurozone has become a net lender to the rest of the world.

This wouldn't matter if the outlook was bright in the rest of the world. But the Eurozone's export-led growth is threatened by a global trade slowdown in part driven by the Trump administration's aggressive stance on trade balances. IHS Markit's manufacturing PMI survey shows that the important German manufacturing sector is contracting at its fastest rate since 2012:

Employment in the sector is falling sharply, and the German economy is forecast to grow at only 0.5% this year. For the Eurozone as a whole, which relies heavily on strong German growth to offset weak economic performances elsewhere, this is yet another signal of a forthcoming downturn.

This poses a considerable problem for the ECB.  Instead of investment going into the domestic private sector, it is leaving the Eurozone, driven away by an over-tight fiscal stance in core countries and continuing debt-driven austerity in many periphery countries. The bloc really needs fiscal stimulus: to be fair, ECB politicians have been pretty explicit about the need for fiscal easing and government investment, especially in core countries. But all the indications are that fiscal policy will, if anything, tighten further. Germany has shown little interest in abandoning its prized "schwarze null" and reducing its enormous trade surplus. The "debt brake" beloved of German politicians is proliferating across the Eurozone. And Brussels is preparing to impose sanctions on Italy for breaking fiscal rules. Meanwhile, investors are already paying Germany to borrow for 10 years or more. Under these circumstances, more QE would be terrible policy. All it would do is reward Germany for the miserliness that is driving the Eurozone economy into the ground.

But QE is not the only policy available to central banks. A genuinely independent ECB could, and should, distribute money directly to households and small businesses. It could, and should, come up with ways of supporting banks to provide credit to productive businesses. It should do all of this, and more, even if some of its shareholders object. That it does not do so arises from its own culture, the willingness to tolerate high unemployment and poor economic performance because of irrational fears about inflation.

The ECB has never in the whole of its history pursued policies that promoted the prosperity of Eurozone citizens. It is time that its mandate was changed to make this its priority. And its new President must be someone who will put aside irrational fears and do "whatever it takes" to end the twin scourges of unemployment and poverty in Eurozone countries.

Related reading:

Inflation in the Euro area - Eurostat
The Case For People's Quantitative Easing - Coppola (available end June)

Image from Wiktionary


  1. Helicopter drops done by central banks would certainly raise demand and inflation, but the trouble is that that inevitably involves POLITICAL decisions: e.g. the decision to distribute money to households rather than small businesses (or vice versa) is POLITICAL.

    I suggest a better system is the one put by Positive Money, Richard Werner and the New Economics Foundation in their submission to Vickers (p.10). Under that system, some sort of committee of economists (e.g. a central bank committee) decides on the size of the deficit (i.e. the amount of money to be created and spent) while political decisions, quite rightly, are left in the hands of politicians. E.g. if a democratically elected government decided it wanted to spend all the money on health and education, who are central bankers to deny politicians the right to take that decision?

    For the Vickers submission see:


    For Bernanke, see para starting “A possible arrangement….” Here:

    1. Ralph, the ECB can decide to create and distribute money indiscriminately to households and small businesses. This would have no effect on Eurozone government deficits unless the ECB had to be recapitalised. And it would not require politicians to decide who should get the money. Indeed it would be important that politicians did not.

      Thanks for the links, but I am completely familiar with them. I have written an entire book on helicopter money. It's out at the end of this month. https://www.amazon.co.uk/Case-Peoples-Quantitative-Easing/dp/1509531300

  2. Frances, Re your first two sentences, I was using the word deficit to refer to the deficit of government(s) and central bank(s) considered as one unit, which is how MMTers often view "government". I should have made that clear.

    I agree that a central bank funded helicopter drop does not "require politicians to decide who should get the money" in what might be called a legal sense. But in practice, when politicians see money being distributed, I suggest they are going to butt in and demand that they have a say on how much of that stimulus goes to the public sector and how much to the private sector (i.e. households). After all, the question as to what % of GDP goes to the public sector is THE BASIC ISSUE that divides the political left from the political right. I just find it unrealistic that a left of centre government would stand back and let a central bank boost the % going to the private sector and not intervene. Plus while I'm personally on the political right rather than the political left myself, I would fully back a left of centre government's right to do that.

    1. On second thoughts, if a central bank DOES dish out money to households and a left of centre government didn't like that, the latter could always grab the money off households via extra tax and spend it on public sector stuff. But that's bureaucratically more expensive than giving the money DIRECT to public sector spending departments & entities (like the NHS) in the first place.

    2. Ralph, you cannot consider the ECB and government as "one unit". They are separated both by law and by jurisdiction. The ECB is owned by the EU19 states, but it is not subject to them and they are prevented by law from directing its actions in any way. MMT is very clear on this. The governments of the EU19 do not issue their own currency. It is issued by a supranational body over which they have no control. If it decided to give €1000 to every citizen of the EU19, politicians would have no power to prevent it doing so, or to direct who should receive that money. Their only recourse would be to the courts.

  3. Morning Frances

    I just wanted to reply to your point about broad money trends.

    "The ECB has drawn a pretty line purporting to show that M3 growth will get back to its QE level by April 2019,"

    Those are in fact the actual figures with M3 growth rising in 2019 so far. Indeed the 4.7% annual rate of growth of M3 in April represents quite a rally after the 3.5% of August 2018. It is also not far from the 5.2% peak seen a couple of times in the QE era.

    So I am afraid that "At present, the M3 growth rate is declining" needs some revision. It did decline but then improved.

  4. I find you very clear, making this an exciting read. Thank you.


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