Mario Draghi: The ECB president introduced a “bazooka” of loans (©EU2017EE Estonian Presidency. CC BY 2.0)


Among Milton Friedman’s many controversial statements, one stands out for its intellectual provocation. In a 1982 volume co-authored with Anna Schwartz, Monetary Trends in the United States and the United Kingdom, he examined money supply statistics going back over a century. On their basis, he said that the assumption of a constant velocity of circulation of money was “an impressive first approximation”. In other words, changes in money are accompanied by the same proportionate change in national income. If the quantity of money rises by 10 per cent in a year, then so will national income; if the quantity of money triples, then so will national income; and so on.

Dozens of scholars have responded by checking the data, with the resulting consensus being that Friedman was overstating the case. As numerous examples can be cited of significant changes in velocity, movements in money do not always portend exactly similar movements in nominal national income or inflation. However, the critics went too far. The evidence is overwhelming that — in the US, the UK and all countries — large changes in the rate of growth of the quantity of money matter to macroeconomic outcomes.

Let us — for the purposes of this article — suspend the disbelief and set aside scepticism about Friedman’s work; let us take the notion of a constant velocity of circulation as a reasonable working hypothesis; and let us apply that hypothesis to the European single currency from the start in 1999. As will emerge, our analysis will have a deeply worrying message for those who believe — as Europe’s single currency approaches its 20th birthday — that its future is secure.

As far as money growth is concerned, the almost two decades of the euro’s existence split readily into three periods. The first, from the beginning of 1999 to the third quarter of 2008, had an annual rate of money growth of 7.5 per cent; the second, from the onset of the Great Recession at the end of 2008 to the end of 2014, saw the annual rate of money growth dip to a tiny 2 per cent; and in the last and most recent, from the end of 2014 to early 2018, it recovered to 5 per cent.

Anyone persuaded by the monetary approach to economics would expect the first and third periods to have the highest increases in nominal national income, and the middle six-year period the lowest. Further, the middle period might have experienced negligible increases in the price level or even occasional falls. After all, if velocity is constant, a 2 per cent increase in money implies a 2 per cent increase in nominal national income; and, if an increase in output of about 2 per cent is achieved (which might be seen as normal in mature industrial societies), a 2 per cent increase in nominal national income means no change in the price level. That was indeed more or less what happened for the eurozone as a whole on average between 2008 and 2014, much as Friedman might have envisaged.