Fed at Odds with ECB over Value of Policy Tool Financial innovation and the spread of U.S. currency throughout the world has broken down relationships between money, inflation and growth, making...

Fed at Odds with ECB over Value of Policy Tool


Financial innovation and the spread of U.S. currency throughout the world has broken down relationships between money, inflation and growth, making monetary gauges a less useful tool for policy makers, the U.S. Federal Reserve chairman, Ben Bernanke, said. ... The European Central Bank, Bank of Japan and Bank of England all use growth in the supply of money in formulating policy. “Heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the U.S. context,” Bernanke said. ... “The empirical relationship between money growth and variables such as inflation and nominal output growth has continued to be unstable.” ... He said the Fed had “philosophical” and economic differences with European central bankers regarding the role of money and that debate between institutions was healthy. ... “Unfortunately, forecast errors for money growth are often significant,” reducing their effectiveness as a tool for policy, Bernanke said. “There are differences between the U.S. and Europe in terms of the stability of money demand and financial innovation,” Bernanke said. ... [Ultimately,] the risk of bad policy through a devoted following of money growth led the Fed to downgrade the importance of money measures.

a. Explain how the debate surrounding the quantity theory of money could make “monetary gauges a less useful tool for policy makers.”

b. What do Bernanke’s statements reveal about his stance on the accuracy of the quantity theory of money?