THE FED: Money Growth Plays Small Role In Fed Policy: Bernanke
By Greg Robb
WASHINGTON (Dow Jones) -- Money growth measures no longer play a key role in Federal Reserve monetary policy decisions, although the central bank still keeps one eye on the data for clues about the economy, Fed Chairman Ben Bernanke said Friday.
"Although heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the U.S. context, money growth may still contain important information about future economic developments," Bernanke said in prepared remarks to a European Central Bank conference in Frankfurt, Germany.
A copy of his remarks was released in Washington.
Bernanke made no comments about the current state of the U.S. economy in his prepared text or in the question-and-answer session.
Monetarism, the focus on the supply and demand of money to regulate economic activity, had its heyday in the late 1970s and early 1980s, under the leadership of Chairman Paul Volcker.
But the unstable relationship between money growth and economic growth fueled by financial innovations soon led the Fed to abandon money-supply targets.
"It would be fair to say that monetary and credit aggregates have not played a central role in the formulation of U.S. monetary policy" since 1982, Bernanke said.
One problem is that between one-half and two-thirds of U.S. currency is held abroad, Bernanke said. As a result, there can be sharp changes in currency outstanding that is unrelated to domestic conditions.
In contrast, Jean-Claude Trichet, the president of the European Central Bank, said that money still has a vital role in ECB monetary policymaking. There remains a strong correlation in the long run between money growth and economic growth, he said. If money grows faster than the economy, inflation will result. If money grows too slow, economic growth could suffer.
However, short-run movements in the money supply can be misleading, he said.
Trichet said analyzing money supply growth played a key role in the central bank's decision to start its interest-rate hike cycle in December 2005.
Bernanke said the Fed's staff continues to devote "considerable effort" to modeling and forecasting money demand and growth.
Bernanke said whether to target money supply growth or interest rates to achieve the Fed's goal of price stability is a simple empirical question as to which works better. The Fed's view is that interest rates have a more stable relationship to inflation rates than the growth of money supply does.
(END) Dow Jones Newswires
11-10-061224ET
Copyright (c) 2006 Dow Jones & Company, Inc.