The Eurozone’s Money Supply Has Dropped Off… And That’s Actually Good News

The Eurozone’s Money Supply Has Dropped Off… And That’s Actually Good News
Reda Farran, CFA

3 months ago2 mins

Not everyone considers a shrinking money supply a good thing. But the money supply in the eurozone shrank in July for the first time in 13 years, and the European Central Bank (ECB) right now is chalking it up as a win.

To gauge the eurozone’s money supply, the ECB uses the “M3” figure, which lumps together physical cash, bank deposits (with maturities of up to two years), and other very liquid financial assets like money market funds. Put simply, M3 is a broad measurement of all the money that's available in an economy, including not just cash but also various types of deposits and funds that can be quickly turned into cash. And, according to new data, M3 in the eurozone decreased by 0.4% in July from a year ago, down from growth of 0.6% in June.

Driving the decline was a drop in short-term deposits held at banks. This came as households, companies, and institutions shifted funds to longer-term deposits with better interest rates and to higher-yielding fixed-income instruments. A slowdown in bank lending also played a role in driving down deposits and, consequently, M3. See, when banks slow their lending, less money is circulated in the form of loans. People and businesses then have less money to deposit back into banks. And because M3 counts not just physical cash but also various types of deposits, a decrease in lending leads to a smaller amount of these deposits, causing the M3 money supply to shrink.

This all matters because the ECB closely monitors M3 to assess whether its monetary policy tightening (namely: its recent string of interest rate hikes) is working as intended. After all, when the money supply shrinks, it should slow down economic activity and inflation, which has been running at more than double the central bank's target. The latest data, then, suggests that those tightening moves are indeed getting the job done. And that could prompt the ECB to consider pausing its interest rate hikes for the first time since July 2022 when it meets on September 14th.



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