QE has not prevented a decline in broad money velocity

If anything, contemporary monetary developments, in the EMU (like in other major economies), are a reminder that it is simplistic and therefore risky to sum up the fuzzy concept of liquidity with QE as if it was the alpha and omega of monetary phenomena. For the sake of brevity, the following investigation will only refer to EMU data, but its key observations are, to a large extent, valid in other developed economies. In recent years, the EMU has indeed experienced the following monetary phenomena.

Broad money (M3), which is mainly created by commercial banks and their clients, has grown at a much slower pace (+3.7% a year on average since September 2008, +5.6% since December 2014) than the ECB’s balance sheet (+12.5% a year on average since September 2008, +16.7% since December 2014). Up until the Great Financial Crisis, a EUR 1 increase in the ECB’s balance sheet used to be accompanied by a fourfold increase in M3. Over the last five years, this multiplier has fallen to 0.60. So much for the ability of a central bank to control broad money through its own balance sheet!5

Derived from the ratio of nominal GDP-to-M3, the transactions-velocity of broad money has furthermore slowed down (by an average 2% a year since September 2008, 3.2% a year since December 2014), to about 10 times a year before the Covid-19 outbreak, as shown in Figure 1. As such, it has further widened the gap between the ECB’s quantitative impulse and the response of private agents. In other words, since the Great Financial Crisis, the decline in the velocity of money has neutralized or sterilized the first 2 to 3 pp of broad money growth, that is, about 55% of the total. In 2020, the velocity of broad money has exhibited some unusually large fluctuations: declines in Q1 and Q2 of -6.6% and -13.6% respectively, followed by a 10.5% rebound in Q3. So much for the alleged stability of money velocity!