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. Many other central banks use monetary aggregates as a guide to policy decision, but Bernanke believes reliance on monetary aggregates would be unwise because the empirical relationship between money growth, inflation and output growth continue to be unstable. Bernanke said that the Fed had “philosophical” and economic differences with the European Central Bank and the Bank of England 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,” Bernanke said. Ultimately, the risk of bad policy arising from 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?