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ECB Watch: It’s the money supply, stoopid!

Either the underlying money demand relationship on which the M3 reference value is based has failed or there is a lot of pent-up inflation.

The European Central Bank’s top guns led with their chins in defence of their monetary policy strategy at a major conference in Frankfurt last month and emerged bloodied but unbowed. During the fourth ECB Central Banking Conference, “The role of money: money and monetary policy in the 21st century”, ECB president Jean-Claude Trichet, vice-president Lucas Papademos and economics supremo Jürgen Stark all strongly endorsed the continuing importance that the ECB attaches to its monetary analysis, which constitutes one of the two analytical pillars of its monetary policy strategy. As Stark put it in his opening address: “Monetary analysis is a field that has proven essential to central banks for a long time. We therefore need to invest further in it in the future.”

Several eminent participants begged to differ, not least US Federal Reserve chairman Ben Bernanke, who noted that “monetary and credit aggregates have not played a central role in the formulation of US monetary policy” since 1982, although he conceded that “attention to money growth was sensible as part of the eclectic modelling and forecasting framework” used by the Fed. Criticisms were also levelled by academics, among them professor Michael Woodford of Columbia University who, at the end of an in-depth analysis of the economic case, concluded that “a serious examination of the reasons given thus far for assigning a prominent role to monetary aggregates in [policy] deliberations provides little support for a continued emphasis on those aggregates”.

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