TJP

Bernanke Needs to Explain the Policy of Restricting the M1 Growth Rate

By Byron A. Ellis – January 25, 2010

Bernanke needs to explain why the Federal Reserve under his watch allowed the M1 money stock to remain flat from 2003 until the fourth quarter of 2008. The graph below demonstrates that whenever M1 money stock is not allowed to grow, or grows slowly, a recession occurs, the shaded areas are recessions.

It appears that Bernanke, aided by the New York Federal Reserve, implemented the policy of inflation targeting (IT) in the United States. IT is a monetary-policy strategy, introduced in New Zealand in 1990 and over 20 industrialized and non-industrialized countries use it. Its principal feature is an announced numerical inflation target.

Bernanke and his colleagues at the Federal Reserve Bank of New York argued in their book, “Inflation Targeting: Lessons from the International Experience” that IT is beneficial for the United States economy. The graph, however, indicates that restricting the growth of M1 to control inflation led to the 2008 recession. Thus, as a result of IT, US citizens lost significant wealth.

The administration’s continued support of Bernanke is incomprehensible. Either they do not understand the short-term non-neutrality of money or they are not in favor of improving the capacity of the Federal Reserve.

Assume, for simplicity, that the American economy is tantamount to a four family household with a fixed nominal income of say $10,000 per year or $2,500 per family member. If the household expands and becomes a five family household and family income is not allowed to increase, income per family member would decrease to $2,000. Meaning that the household purchasing power per family member would diminish. Likewise, when the American population expands and the Federal Reserve constrains the growth of M1, which is the money that consumers use to purchase goods and services, income per capita diminishes. Moreover, when the cost of energy rises due to speculation, real purchasing power is adversely affected. Lower consumers' purchasing power causes inventory accumulation and layoffs.

Therefore, anyone who supports Bernanke and the New York Fed under Geithner does not understand how a no growth monetary policy affects the wealth of Americans. The administration needs to seriously reevaluate its support for the architects of the Bush administration inflation targeting policy.

SAVE DARFUR