Money fulfills three functions: as a store of value, unit of account, and medium of exchange. Its value is determined by these three objectives, with the interest rate as its price. The current prolonged scenario of negative interest rates in Europe, however, is not a sufficient condition to increase the demand for money. Economic agents need future certainty to spend and invest, among other things.
In the past, central banks based their monetary policy decisions on estimates of the evolution of money demand. The monetary rule linked the nominal growth of the economy with the growth of the money supply that financed it. The instability of this relationship in the short term led the European monetary authority to replace the money supply target with a liquidity reference. It was decided to set it at the monetary aggregate (M3), which included cash, banknotes, and deposits. This decision also offered greater room for maneuver to set the appropriate monetary conditions at each moment without being overly concerned if M3 rose beyond levels consistent with the 2.0% inflation target, as is happening now.
The money supply in the eurozone grew 8.4% in May year-on-year, almost double the level considered as a medium-term reference. The strong monetary expansion carried out by the European Central Bank (ECB) since the beginning of the crisis has a dual objective: to maintain favorable financial conditions for households and businesses through the work of banks, and to strengthen financial stability by reducing volatility in financial markets. Against the rise in financial asset prices throughout this period, inflation of goods and services has remained contained in a scenario of economic weakness and uncertainty. Inflation is a monetary phenomenon, although this statement should not lead to automatic monetary policy decisions.
Deposits are the main component of M3 and one of those that has risen most in recent months. They are already one of the main financial assets of European households, which have accumulated an unprecedented level of savings in recent history, an unmistakable sign of their confidence in the security offered by banks in this environment where savings are penalized by low official interest rates. The evolution of deposits in the coming months will depend on the expected return to economic normality and a scenario with fewer uncertainties.
The main counterpart of M3 is credit, which has also accelerated since the beginning of the health crisis. Credit granted to the public sector is growing at rates of 15.4%, while financing to the private sector is doing so at 7%. Authorities and banks have devoted themselves to households and businesses to mitigate the negative impact of the pandemic. Offsetting lost income, providing the necessary liquidity under the best possible conditions, and facilitating loan repayment have been key to overcoming the crisis. And to paving the way for a sustainable and lasting economic recovery once we have overcome the virus.
At this time, it is vital that authorities and other economic agents take the necessary measures to underpin the recovery and make it sustainable over time. Fiscal policy and structural reforms will be key to economic reactivation, taking over from the ECB. The banks’ commitment is to drive growth as much as possible, leveraging their strength and financing capacity.
José Luis Martínez Campuzano, Spokesperson for the Spanish Banking Association
