Money and credit dynamics in the euro area and a comparison with the United States

Prepared by Ramón Adalid, Lucía Kazarian, Davide Malacrino and Silvia Scopel

Published as part of the ECB Economic Bulletin, Issue 6/2024.

This box examines the recent transmission of monetary policy to money and credit volumes and interest rates in the euro area and compares it with that in the United States, highlighting key differences and similarities during the pandemic period. First, interest rates on deposits have reached higher levels in the euro area than in the United States (the US), despite a smaller increase in the policy rate and a lower starting point. Second, since the start of monetary policy tightening, credit growth has declined more sharply in the euro area, possibly owing to stronger demand and more abundant deposits in the US. Third, the moderation in US broad money growth from its pandemic peak appears much greater, as asset purchases by the US Federal Reserve System (the Fed) during the pandemic were almost double those by the Eurosystem, expressed in terms of GDP.

Interest rates on customer deposits have reached higher levels in the euro area despite a smaller increase in the policy rate and a lower starting point. As monetary policy tightened, deposit rates increased in both the euro area and the US.^[1] Time deposits reacted faster and stronger than overnight deposits in both economies – as in the 2000s, when policy rates were well into positive territory (Chart A, panels a) and b). However, transmission was considerably stronger in the euro area than in the US. Despite a lower policy rate (4% in the euro area compared with a range between 5.25% and 5.50% in the US), in March 2024 the weighted average remuneration of short-term time deposits was above 3% in the euro area, while in the US it had not reached 2%. Overnight deposits reveal a similar picture, at slightly above 0.5% in the euro area while falling short of 0.1% in the US (Chart A, panel c).

Chart A

Interest rates on outstanding amounts of customer deposits

(percentages per annum)

Having accumulated more deposits during the pandemic, US banks saw larger shifts away from deposits during the tightening cycle, partly owing to higher returns from bonds and competition from money market funds, which traditionally account for a larger share of portfolios in the US than in the euro area. Overnight deposits surged in both economies during the pandemic period, in a context of low interest rates, monetary expansion and forced savings. As monetary policy tightened, returns on other saving instruments increased and funds started to shift away from the most liquid deposits. During the tightening cycle, liquid deposits recorded outflows of 11% of GDP in the US, compared with less than 8% in the euro area, bringing M1 growth into deeply negative territory in both economies. The volume of deposits accumulated prior to the tightening cycle, which was more striking in the US than in the euro area, may have reduced banks’ incentives to increase deposit rates, at least initially. This has likely contributed to keeping the spread between government bond yields and deposit rates consistently wider in the US than in the euro area since the second quarter of 2022 and also helps to explain the larger deposit outflows in the US (Chart B). Accordingly, US money holders shifted more funds into bonds (about 10% of GDP) than into time deposits (about 8%), while in the euro area time deposits received most of the inflows (almost 9% of GDP compared with just above 3% shifted into bonds). Inflows into money market funds were also considerably larger in the US (5% of GDP) than in the euro area (1%), although this is in part attributable to the period of turbulence surrounding the failure of Silicon Valley Bank, which was triggered by concerns about the solvency of US regional banks. About half of the US inflows into money market funds were recorded around that period. More recently, as the tightening cycle has matured, inflows into time deposits, bonds and money market funds have moderated in both economies.

Chart B

Portfolio rebalancing

a) Euro area

(left-hand scale: percentages of annual GDP; right-hand scale: percentage points)

b) United States

(left-hand scale: percentages of annual GDP; right-hand scale: percentage points)

As policy rates increased, credit to firms fell more sharply in the euro area than in the United States, while the pass-through to lending rates was similar. After the large swings in credit growth between 2020 and 2021, firms’ external debt financing began to contract soon after the ECB and the Fed started their hiking cycles. The annual growth rate of firm credit (bank loans and corporate bonds) fell more in the euro area, dropping from a peak of 7.4% in August 2022 to 0.7% in the span of 12 months. US firms saw a smaller decline, as the growth rate fell from the peak of 5.4% in the third quarter of 2022 to 2.2% in the fourth quarter of 2023 (Chart C). Including non-bank loans, the differences remain but become somewhat smaller. The smaller decline in US firm credit growth may reflect stronger credit demand in the more resilient economy and the still greater abundance of deposits in the US following the stronger quantitative easing in response to the pandemic. Moreover, it likely reflects a slightly weaker pass-through of monetary policy to firm lending rates. Indeed, although the Fed raised its main policy rate by 525 basis points between February 2022 and August 2023 – 75 basis points more than the ECB did during its tightening cycle – the lending rates on new loans to firms increased by about 3.8 percentage points, only 20 basis points more than in the euro area (Chart D). The ratio of the change in lending rates to the change in the policy rate was 72% in the US, slightly below the figure of 79% for the euro area. Yet, the change in the average rates on outstanding amounts was close to 50% of the policy rates in both economies. Nevertheless, given the higher starting levels, lending rates are substantially higher in the US than in the euro area.

Chart C

Total credit to firms excluding non-bank loans

a) Euro area	b) United States
(annual percentage changes)	(annual percentage changes)

Chart D

Cost of debt financing for firms

a) Euro area	b) United States
(percentages per annum)	(percentages per annum)

Household credit dynamics have been weaker in the euro area, with falling mortgage growth and quicker transmission to rates on existing mortgages, despite lower interest rates on new loans than in the US. In the euro area, the annual growth rate of loans to households has declined from its peak of 4.6% in May 2022 to about 0.2% in recent months. The US has seen a larger drop of 5.5 percentage points between the first quarter of 2022 and the fourth quarter of 2023, but the decline began from a much higher level owing to record high mortgage issuance during the pandemic. Hence, the growth rate in the US still stood at 2.7% at the end of 2023, with the contribution of lending for house purchase standing close to its pre-pandemic level (Chart E). The rate on new mortgages increased more robustly in the US than in the euro area. US mortgage rates (on both five-year adjustable and fixed rate mortgages) grew by about 4 percentage points, i.e. around 75% of the policy rate increase, compared with a 2.1 percentage point increase in the composite cost of borrowing in the euro area, i.e. close to 47%. But transmission to interest rates on outstanding amounts was significantly slower in the US. Owing to the greater prevalence of fixed rate mortgages in the US, these rates increased by only 43 basis points, compared with 74 basis points in the euro area (Chart F).

Chart E

Loans to households

a) Euro area	b) United States
(annual percentage changes)	(annual percentage changes)

Chart F

Mortgage rates

a) Euro area	b) United States
(percentages per annum)	(percentages per annum)

These developments were mirrored in broad money growth, with high US deposit volumes reflecting the much larger pandemic-related asset purchases by the Fed. Just before the outbreak of the pandemic, the dynamics in broad money growth were similar in both economies. M3 in the euro area and M2 in the US are the key and most comparable monetary aggregates. While there are some differences in scope and definition, this should not affect the major trends under consideration. The policy response to the pandemic emergency was similar in qualitative terms on both sides of the Atlantic, with strong support provided by the central bank via asset purchases complemented by regulatory and monetary policy easing measures to facilitate the flow of credit to the real economy. This boosted money growth. The size of these purchases (and of the fiscal expansion) was, however, much larger in the US (one year after the outbreak of the pandemic, it totalled about 15% of 2019 GDP in the US, compared with less than 9% in the euro area). This translated into much larger money growth in the US, peaking at 26.8% compared with 12.6% in the euro area.

During the policy rate hiking cycle, the weakening of money creation in the euro area was driven by bank lending, whereas in the US, other sources were the initial drivers, with bank lending only contributing later. In August 2022, just after the first policy rate hike, euro area M3 growth was around 6%, with bank loans to firms and households contributing over 4.5 percentage points (Chart G). Eurosystem asset purchases added over 3 percentage points but were offset by external monetary outflows and bank sales of government bonds, both influenced by the Eurosystem purchases. By September 2023, the contribution of bank lending had become virtually nil and annual M3 had dropped to around -1%. While US M2 growth also turned negative during the hiking cycle, counterparts other than lending (namely bank purchases of securities, external monetary flows, banks’ wholesale funding and quantitative tightening) played the dominant role. It was only from March 2023 that bank loans in the US started to contribute less to annual M2 growth.

The moderate turnaround in US M2 growth reflects reduced bank wholesale funding and, to a lesser extent, banks’ purchases of bonds and foreign flows, whereas foreign inflows are the main factor behind the turnaround in euro area M3 growth. US M2 growth reached a trough of -4.5% in April 2023, dragged down by the Fed’s quantitative tightening and all other sources of money creation except bank lending. Since then, the reduction in the Fed’s securities portfolio has strengthened contractionary effect of quantitative tightening, but other counterparts except bank lending have pulled M2 growth back towards zero. While US net foreign flows were supported by portfolio investment as in the euro area, the persistent current account deficit in the US has dampened overall monetary inflows from abroad.

Chart G

Sources of money creation

a) Euro area

(annual percentage changes)

b) United States

(annual percentage changes)