Broad Money Growth and Post-COVID Inflation in the Euro Area

What the paper says

After many months of pandemic-related restrictions and economic disruption, inflation in the Euro Area began to rise sharply in 2021. The European Central Bank (ECB) initially characterized this increase as temporary and attributed it mainly to supply-side shocks, such as energy price increases and supply-chain bottlenecks. This study revisits that narrative by examining whether monetary developments had already signaled more persistent risks. Using the framework of the Quantity Theory of Money, we analyze the divergence between broad money (M3) and real GDP growth and construct an indicator of Hidden Monetary Imbalances (HMI) that captures the portion of liquidity growth not yet absorbed by output or prices. In response to the Great Financial Crisis and the COVID-19 pandemic, the ECB implemented highly accommodative policies, resulting in an unprecedented surge in liquidity. Our descriptive evidence shows that, since 2015, the growth of the money supply has systematically outpaced the expansion of the real economy. As money velocity normalized, this excess liquidity contributed to inflationary pressures. Our results suggest that by 2020, excess liquidity would already imply a cumulative price-level adjustment of more than 30% if output and velocity remained unchanged. Inflation subsequently accelerated, with the HICP rising above 5% in early 2022 and peaking at 10.6% in October 2022, before remaining above the ECB's 2% target until late 2024. The findings highlight the limitations of relying solely on inflation targeting without monitoring monetary aggregates. Reintroducing systematic monetary cross-checks, including the tracking of broad money and diagnostics such as HMI, could improve the ECB's ability to anticipate inflationary risks.