Sunday, 13 March 2011
What is the ECB doing with its monetary base?
I first saw this chart on Prof David Beckworth’s blog. The chart is a strange one. The vertical axis is the monetary base in trillions of Euros, and the horizontal axis is time, ranging from Feb 1999 to Feb 2011. Anyone got any explanations?
You’d have thought the cautious ECB would not want to expand the monetary base (in nominal terms) faster than the real expansion of the Euro economy (say 2% a year) plus the target rate of inflation (say 2%). That means roughly 4% ( 2 + 2 = 4%). But the rate of expansion on the chart is well over 10%.
My explanation is that while central banks are supposedly in charge, prior to the credit crunch, commercial banks were forcing an expansion of several developed economies and their monetary aggregates (based on dodgy collateral – property prices). The ECB could have reined in this expansion by raising interest rates to unprecedented levels, which would have stifled activity in non-property sectors. But what they actualy chose to do was join the party, and expand the monetary base.
What would have been really smart on the part of the ECB (and other central banks) would have been to spot the property bubble, and curtail loans based on property. But that would probably have been politically impossible because of howls of anguish from home buyers.
I think Steve Keen said that prior to the crunch, the tails were wagging central bank dogs.