Policy brief

The monetary mechanics of the crisis

Publishing date
27 August 2009

In response to the financial and economic crisis, central banks, unlike in the 1930s, have created enormous amounts of money. There are fears that this will lead to inflation, but it is base money (the central bank's liabilities) that has expanded; total monetary aggregates have not. By contrast, in the 1930s, base money remained stable and monetary aggregates dropped. The reason for this is that in a crisis the relationship between the base money and monetary aggregates is altered. The money multiplier drops. It is therefore necessary to create more base money so that monetary aggregates remain stable.

This is what central banks have done in the current crisis – and rightly so. They have learned the lessons of the Great Depression. This framework helps understand differences across countries. The crisis affected the euro area money and credit supply process much less than the US and the UK. Therefore, the European Central Bank was right to respond to the crisis with a less expansionary monetary policy than the Bank of England and the Federal Reserve. However, stabilising the money supply may not have been enough to stabilise the supply of credit.

About the authors

  • Jürgen von Hagen

    Jürgen von Hagen, a German citizen, was Bruegel'‘s first Non-resident Senior Fellow. His widely acclaimed work on European integration addresses public finance and political economy issues.

    Jürgen is the Director of the Center for European Integration Studies in Bonn, a Research Fellow of the CEPR and a member of the Academic Advisory Council to the German Federal Minister of Economics and Labor.

    He has previously taught at Indiana University (1987-92) and the University of Mannheim (1992-96). His current interests include macroeconomics of European integration and the euro area and European public finance.

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