Monetary policy has ventured even further into uncharted territory over the past years. Gone are the times when changes in interest rates were the sole policy variable that drew the attention of the public and financial markets. Today, central bank policy pronouncements are as much or even more about unconventional policy tools—such as asset purchase programmes—than they are about interest rates.
The European Central Bank (ECB) is no exception. Over the past years, it has purchased ever increasing amounts of bonds, prompting warnings of drastically high inflation. Some critics believe that a flood of money entering the market is chasing far too few goods. This is reinforced by the run-up in the price of various assets, such as real estate and equities. As a consequence, even the spectre of looming hyperinflation is making the rounds among observers.
However, a closer look at the mechanics of monetary policy of the ECB reveals a somewhat unexpected picture. There has been a sharp increase in the monetary base, but this stemmed mainly from the interactions between commercial banks and the ECB as the central bank. On a broader scale, the supply of money has been growing much more slowly and is largely within the range needed to maintain price stability and avoid runaway inflation.
This will be reassuring to those fearing higher inflation from unconventional policies by the ECB. At the same time, it illustrates the very policy challenge at hand: the persistent inability of policymakers to reach their inflation target, to the point where deflation – that is falling prices – is the more imminent and serious challenge.
In addition, the behaviour of monetary aggregates indicates that while the ECB’s asset purchases have so far not created inflation pressure, fragile balance sheets of the banking sector might require more forceful policy responses in the future.
Read the November Monthly Briefing for more details.