By Leonardas Marcinkevičius, a senior expert at the Lithuanian Free Market Institute
In 2021, the European Central Bank (ECB) was looking at almost exactly what it sees today: a jump in energy prices and rising headline inflation. What we heard back then, though, was the reassuring explanation that inflation was “transitory” and that things would soon return to normal. The ECB then waited roughly a year. That is how the whole euro area came to live through double-digit inflation at the end of 2022.
This time the Governing Council is behaving differently. At its meeting on 10 September it raised the key interest rates by 25 basis points, to a range of 2.50–2.90%. It was the second increase this year. That suggests the lessons of the pandemic have at least partly been learned — and that today’s energy shock need not turn into inflation on the scale of 2022. Policymakers acted with good reason this time. But a single decision will certainly not dispose of the systemic problem of persistent inflation.
This time the energy shock was not an excuse to wait
In August euro-area headline inflation rose to 3.3%, from 2.9% in July, and the largest single contribution came from energy — fuel, electricity and heating — which was 14.3% higher than a year earlier. Services inflation, meanwhile, eased from 3.3% to 3.0%. Had the ECB followed the same logic it used five years ago, doing nothing would have been perfectly consistent. The argument then was that prices were being pushed up by an external shock, while core inflation — price growth excluding energy and food, which central banks watch precisely because it is less exposed to outside forces — was cooling. This time the ECB did not reach for that argument.
Nothing shows the difference in reaction speed better than the calendar. By April 2021 euro-area energy prices were already 10.4% higher than a year before, yet the ECB did not raise rates until July 2022 — fifteen months later, by which point energy had become some 42% higher and headline inflation stood at 8.6%. This April energy prices were up by almost exactly the same amount, 10.8%, and the first increase followed two months later, in June. In other words, the ECB has just responded to a reading it previously ignored for more than a year.
The reason shows up in its own projections. In the baseline scenario, ECB staff now expect headline inflation to average 3.0% in 2026, 2.5% in 2027 and 2.1% in 2028. Core inflation, however, is projected to be higher in 2027 than in 2026 — 2.6% against 2.5% — before easing to 2.3% in 2028. Compared with the June round, the 2027 and 2028 figures have been revised upwards. Which means the ECB’s own economists no longer believe the energy shock will burn itself out without touching everything else.
A rate rise is a response to an external virus
To judge whether the decision was justified, it helps to compare the monetary system to an immune system — or more precisely, to the way the monetary order determines how well an economy can absorb a blow from outside. A virus can reach the body regardless of anything the person has decided: this time the virus is the conflict in the Middle East and the energy prices that came with it. But the same virus affects different bodies differently. One runs a fever, another gets no more than a runny nose, and a third notices nothing at all.
Inflation is that fever. In a healthy system, dearer energy would merely reshuffle spending: paying more at the pump, households would give up something else, and the prices of those other things would start to fall — or consumers would simply burn less fuel. The general price level would not move much. Only relative prices would. Once immunity has been run down, however — once central banks and governments have poured ever more money into the economy — the very same energy shock turns into a general jump in prices.
That contrast is exactly what the pandemic showed. The money supply is usually measured by several aggregates. Narrow money, M1, covers cash in circulation and overnight deposits: money that can be spent immediately. Broad money, M3, is wider still, adding short-term deposits and marketable instruments. During the pandemic both grew at a pace the euro area had never seen: in January 2021 M1 was up 16.4% on the year and M3 up 12.5%. Together with zero interest rates and the Pandemic emergency purchase programme (PEPP), under which the ECB bought roughly €1.7trn of securities, this meant that the quantity of money in circulation rose by about a quarter in two years while the output of goods and services barely moved at all. Inflation duly reached double digits: the economy’s health had simply been run down by cheap money.
Today the picture is different. On July’s figures, euro-area M1 grew by 3.1% over the year and M3 by 3.4% — roughly five times slower than at the start of 2021. That is the single most important difference in weighing up the September decision: the money printing is no longer being encouraged. It does not restore immunity by itself, but at least it is not draining what remains.
One decision will not cure a chronic condition
Beneath all this lies a deeper problem, and no meeting of the Governing Council will solve it. An interest rate is, by its nature, also a price: the reward for one person deferring consumption so that another can invest or spend that money today. It reflects how much people value goods now against the same goods later. In a fully free monetary system that price would emerge from millions of independent decisions by those who want to borrow and those willing to lend, and it would register whether people were inclined to save more or to spend more.
In the euro area, interest rates are not set by borrowers and lenders but at the central bank’s headquarters in Frankfurt. The ECB therefore chooses which historical data to weigh and which targets to set, and only later, by watching the economy, can it judge whether it got the call right. Policymakers admit as much themselves. When they discuss the “neutral” rate of interest — the level that would neither stimulate nor restrain the economy — they keep repeating that nobody knows its exact value. Which is why the argument over whether rates have been raised too much or too little never ends, and cannot end. There is simply no single right answer, because a central planner always faces the same difficulty: it has to create the impression of knowing something that could never fit in any database — the valuations and the daily choices of more than 300 million people who use the euro.
Second, monetary policymakers can only manipulate the price of credit. A higher interest rate changes the decisions of households and firms straight away: a mortgage is put off, an investment is dropped, a larger share of income goes on servicing a loan already taken. Government spending, however, is not visibly altered by higher rates — they merely raise the cost of servicing the debt. And in today’s political climate that tends to become an argument for borrowing more rather than less. The ECB knows this perfectly well, which is why its September statement stressed that fiscal responses to the energy shock should be “temporary, targeted and tailored”. The observation is sound, the central bank simply has no instrument to enforce it. If monetary policy suppresses private consumption while governments keep pushing money into the economy, Europeans will end up facing both higher loan payments and higher prices.
So, working with the instruments they have, policymakers took a better-founded decision than they did during the pandemic. That caution is worth acknowledging: waiting in 2021 cost Europeans double-digit inflation. One can only hope that this time Europe’s economic immune system is ready to see off the virus of the Middle East conflict. The chronic illness, though — the price of money being set from a single centre rather than in a market — is not something the September decision cures. Which leaves the residents of the euro area still relying on the services of a doctor who is also one of the sources of the disease.
This comment piece draws upon a new EPICENTER and LFMI paper, “Money Supply Returns to the Path of Growth: Has the ECB Learned from the Pandemic?”, which uses euro-area data from 1999 to 2025 to show how ECB decisions drive money supply, and how expansion resumed in 2024 once rate cuts began.
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