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Europe’s Special Inflation Risks

If the economy recovers and fiscal stimulus turbocharges pent-up demand, a lot of bank credit could suddenly emerge from central bank money. Price growth will then begin to accelerate, and the European Central Bank will have a very hard time curbing it without having a functioning inflation brake.

MUNICH – The increasing risk of a return of inflation in the United States and Europe is beginning to galvanize debates among economists. One key source of inflation fears is the expectation that, once the COVID-19 pandemic has been overcome by vaccines, pent-up demand will explode in an orgy of consumption. Moreover, today’s unprecedentedly large government bailout programs will have powerful inflationary multiplier effects.

But the international debate has been strangely US-centric. Few people have yet considered the particular inflationary dangers that lurk in the eurozone, where the monetary base has risen in recent years to a much higher level than in the US, relative to annual economic output.

In January 2021, this ratio, known as the cash-holding coefficient in the economy, was 43% in the eurozone, almost double the 24% recorded in the US. By contrast, when the global financial crisis began in 2008, the figures were almost identical – 12% and 11%, respectively.