Home > Recession > The European Central Bank is repeating an old mistake….

The European Central Bank is repeating an old mistake….

from Merijn Knibbe

On Voxeu, Douglas Irwin argues that the 1937 depression (an 11% contraction of GDP…) was caused by monetary tightening in a still depressed economy:

“If we are to avoid the mistakes of the past, it is important to have an accurate assessment of what those past mistakes were. The severity of the Recession of 1937-38 was not due to contractionary fiscal policy or higher reserve requirements. By contrast, the policy tightening associated with gold sterilisation was not modest – it did not simply reduce the growth of the monetary base by a few percentage points, it stopped its growth altogether. While the Federal Reserve is often blamed for its poor policy choices during the Great Depression, the Treasury Department was responsible for this particular policy error.

The recession of 1937-38 occurred long ago, but it does have policy lessons for today. It suggests that, in a weak recovery, a pre-emptive monetary strike against inflation (which was very low at the time, as it is today) is capable of producing a devastating recession.

Alas, the ECB is repeating this exact mistake… (see graph below). According to their press releases, they want to be ‘ahead of the curve’. Money growth is clearly below nominal GDP growth (about 3%) and surely below targeted nominal GDP growth (about 6%). (Targeted? There is no target, in the EU, but during a recovery from a severe depression 6% should be possible).

Graph 1. Money growth (M3) in the Euro area. Source: ECB.

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