Inflation in the Eurozone
Since the Euro was introduced in 1999, the inflation rate in the EU has been around 2% on average. That is, until the COVID pandemic swept across the world in early 2020. In 2021, inflation in the Eurozone shot up to 5%, and has now, in July 2022, reached over 8%.
The European Central Bank (ECB) is responsible for setting monetary policy in the Eurozone. It is their role to adjust policy such that inflation stays low and steady, with 2% being the target.
Why is inflation so high at the moment?
You will likely read of many reasons why inflation has increased in recent years – from supply chain problems, to energy supply problems, to the war in Ukraine. All of these factors have undoubtedly played a role.
What you are less likely to hear about is one major contributor to the current high rate of inflation, namely; the sharp increase in the money supply in the Eurozone, which was the result of the ECB’s expansionary monetary policies, implemented from March 2020 onwards.
The ECB's balance sheet before and after COVID
The ECB bought enormous amounts of securities during the pandemic, thus increasing the money supply in the Eurozone, to enable the national governments to implement their expensive COVID measures and to keep the economy stimulated.
According to the financial statements of the ECB, their balance sheet increased €112 billion in 2020 and €111 billion in 2021, mostly due to the purchase of securities under the Pandemic Emergency Purchase Program (PEPP).
ECB balance sheet is now close to a whopping €9 trillion, a near doubling of their 2019 balance sheet, which stood at just above € 4.5 trillion.
Does the ECB have the tools to get inflation back under control?
Christine Lagarde has been at the helm of the European Central Bank since 2019, and it is now her role to implement policies to tackle the high inflation.
Here she is in a recent interview with the Dutch College Tour in Amsterdam, responding to the interviewer’s question about how the ECB intends to combat inflation.
The truth is, the ECB is running out of tools that it can use to tackle inflation – as are most central banks around the world.
Given the unprecedented levels of global debt which has amassed since the 2008 economic crisis, if interest rates are raised in any significant way, this debt will become inserviceable.
The winners and the losers
This is where we come back to the ‚Cantillon Effect‘ of increasing the money supply.
Those closest to the source benefitted the most from the enormous amounts of new money which was pumped in to the Eurozone economy by the ECB during the COVID crisis.
That is, the banks, who could increase lending, while paying 0% or even negative interest rates on deposits. The companies, who could increase borrowing at low interest rates to invest and grow their companies. The investors, who could borrow at low interest rates to purchase stocks and shares, real estate, and other assets, all of which shot up in value during the pandemic.
Who benefitted the least from the increase in the money supply? Those who were not in a position to be able to borrow and invest when money was cheap and abundant. The very same ones who are now most affected by the high inflation caused by the increase in the money supply.
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