Central banks and money supply: is this time different?

Chart of the week

The crisis caused by the Covid-19 pandemic has led central banks to adopt large-scale measures that have inflated their balance sheets to extraordinary proportions in record time. In less than a year, the total size of the principal central banks’ balance sheets has swollen from about $20,000 billion to almost $30,000 (Fed, ECB, PBoC, BoJ, BoE, BoC, Riskbank, SNB). The question is, will this cause inflation?

Some may argue that quantitative easing, whereby central banks aim to increase their balance sheets to pump liquidity into the economy, has never really pushed prices higher, neither when Japan first implemented this policy response in the early 2000s, nor since the major financial crisis led it to be used more widely (in Japan again in 2013, but also in Europe and the United States).

Our analysis

The graph above illustrates what may be the missing link in the transmission process. Taking Japan as an example, neither in the early 2000s nor from 2013 onwards did quantitative easing significantly increase the broad M2 and M3 money supply. The credit multiplier effect within the financial system was at a standstill. Unlike today. Currently, as a result of central bank action and government transfers, the broadest monetary aggregates are sharply accelerating. In Japan, M2 and M3 growth rates are at their highest since the real estate bubble burst in the early 1990s.

Does this mean that inflation is about to accelerate? Not necessarily. While money supply growth rates are very high (+25% in the United States, +12% in the eurozone), the link between money supply and inflation in developed economies is not as strong now as it has been in the past. The question therefore remains unanswered, as we cannot count on our experience of previous QE programmes to enlighten us this time around.

Overall, the first results coming out of Israel offer hope for the rest of the world and the economy.


See also: https://latribune.lazardfreresgestion.fr/en/israel-early-data-that-can-provide-hope-to-the-rest-of-the-world/

Fed : Federal Reserve System (Central Bank)

BCE : Banque Centrale Européenne

PBoC: Banque Populaire de Chine (Central Bank)

BoJ: Banque du Japon

BoE: Bank of England

BoC: Bank of China, one of the principal commercial Chinese Bank

SNB: Swiss National Bank

M2, M3 : M0 and M1, for example, are also called narrow money and include coins and notes that are in circulation and other money equivalents that can be converted easily to cash. M2 includes M1 and, in addition, short-term time deposits in banks and certain money market funds.1 M3 includes M2 in addition to long-term deposits.

The opinion expressed above is dated 12th February 2021 and is liable to change.


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