ECB’s Schnabel: Deceleration of Money Growth No Signal of Monetary Policy Overtightening

25 September 2023

By David Barwick – Frankfurt (Econostream) – European Central Bank Executive Board member Isabel Schnabel on Monday suggested that concerns of monetary policy overtightening based on the marked deceleration of money growth were misplaced.

In remarks at a conference in Regensburg, Germany, Schnabel said that ECB tightening measures were ‘having a material effect on money dynamics, supporting disinflation.’

Despite ‘clearly moderating’ economic activity, the slowdown of different measures of money growth did not necessarily signal that the tightening had gone too far, given ‘two reasons why monetary developments may currently not be a reliable measure of economic activity’, she said.

One reason was that real M1 growth was a better indicator of the evolution of future real GDP than of an economic slump, she said. ‘Sharp declines in real M1 growth were often accompanied by relatively moderate declines in the annual growth rate of real GDP’, she said.

A second reason was that M1 volumes hinged on the cost of the alternative of very liquid deposits, which prior to the pandemic were unusually low, leading M1 to rise far above its historical average, she said.

‘The sharp rise in interest rates has fundamentally changed this dynamic’, she said. Portfolio rebalancing in pursuit of higher returns had helped depress M1, and was also behind the use of some deposits to be invested beyond the scope of M3, she said.

‘For example, over the past year households have almost doubled their holdings of government bonds, and they have built significant additional exposures to government debt through investment funds’, she said.

With M1 as a share of M3 still relatively high, M1 could be expected to sink further, she said. If M1 regained its traditional proportion of M3, that would imply M1 outflows of around €2 trillion, she said.

‘Similarly, current negative M3 growth is consistent with households and firms bringing their portfolios closer into line with historical regularities’, she continued.

This rebalancing would not per se impact decisions regarding consumption and savings, she said.

‘Higher interest rates may induce households to save more’, she said. ‘But these effects would come on top of the reallocation of the existing stock of savings.’

‘Therefore, in the absence of other mechanisms at work, the current magnitude of the decline in real M1 growth says relatively little about the extent of the slowdown in economic activity in the euro area and the future evolution of inflation’, she said.