Ben S Bernanke: Monetary aggregates and monetary policy at the Federal 
Reserve - a historical perspective  

Remarks  by  Mr  Ben  S  Bernanke,  Chairman  of  the  Board  of  Governors  of  the  US  Federal  Reserve 
System,  at  the  Fourth  ECB  Central  Banking  Conference  "The  role  of  money:  money  and  monetary 
policy in the twenty-first century", Frankfurt am Main, 10 November 2006.  

*      *      * 

My topic today is the role of monetary aggregates in economic analysis and monetary policymaking at 
the Federal Reserve. I will take a historical perspective, which will set the stage for a brief discussion 
of recent practice. 
The Federal Reserve's responsibility for managing the money supply was established at its founding in 
1913,  as  the  first  sentence  of  the  Federal  Reserve  Act  directed  the  nation's  new  central  bank  "to 
furnish an elastic currency."1 However, the Federal Reserve met this mandate principally by issuing 
currency  as  needed  to  damp  seasonal  fluctuations  in  interest  rates,  and  during  its  early  years  the 
Federal  Reserve  did  not  monitor  the  money  stock  or  even  collect  monetary  data  in  a  systematic 
way.2,3  
The Federal Reserve's first fifteen years were a period of relative prosperity, but the crash of 1929 
ushered in a decade of global financial instability and economic depression. Subsequent scholarship, 
notably the classic monetary history by Milton Friedman and Anna J. Schwartz (1963), argued that the 
Federal  Reserve's  failure  to  stabilize  the  money  supply  was  an  important  cause  of  the  Great 
Depression. That view today commands considerable support among economists, although I note that 
the sources of the Federal Reserve's policy errors during the Depression went much deeper than a 
failure  to  understand  the  role  of  money  in  the  economy  or  the  lack  of  reliable  monetary  statistics. 
Policymakers of the 1930s observed the correlates of the monetary contraction, such as deflation and 
bank failures. However, they questioned not only their own capacity to reverse those developments 
but  also  the  desirability  of  doing  so.  Their  hesitancy  to  act  reflected  the  prevailing  view  that  some 
purging of the excesses of the 1920s, painful though it might be, was both necessary and inevitable. 
In any case, the Federal Reserve began to pay more attention to money in the latter part of the 1930s. 
Central to these efforts was the Harvard economist Lauchlin Currie, whose 1934 treatise, The Supply 
and  Control  of  Money  in  the  United  States,  was  among  the  first  to  provide  a  practical  empirical 
definition  of  money.  His  definition,  which  included  currency  and  demand  deposits,  corresponded 
closely to what we now call M1. Currie argued that collection of monetary data was necessary for the 
Federal Reserve to control the money supply, which in turn would facilitate the stabilization of the price 
level and of the economy more generally.4 In 1934, Marriner Eccles asked Currie to join the Treasury 
Department, and later that year, when Eccles was appointed to head the Federal Reserve, he took 
Currie  with  him.  Currie's  tenure  at  the  Federal  Reserve  helped  to  spark  new  interest  in  monetary 

                                                      
1   Board  of  Governors  of  the  Federal  Reserve  System  (1998),  1-001.  In  his  recent  history  of  the  Federal  Reserve,  Allan 
Meltzer (2003, p. 66) notes of some of the Act's proponents that: "[o]ne of their principal aims was to increase the seasonal 
response, or elasticity, of the note issue by eliminating the provisions of the National Banking Act that tied the amount of 
currency to the stock of government bonds." 

3  

2   See  Mankiw  and  Miron  (1986)  for  a  discussion  of  the  Fed's  seasonal  interest-rate  smoothing.  The  Federal  Reserve  did 
publish data on the issuance of Federal Reserve notes from its inception. Federal Reserve notes were only part of total 
currency in circulation, however, the remainder being made up of national bank notes, United States notes, Treasury notes, 
gold  and  silver  certificates,  and  gold  and  silver  coin.  Beginning  in  1915,  the  Federal  Reserve  Bulletin  included  data  on 
currency that had been collected by the Treasury and data on total bank deposits that had been collected by the Office of 
the Comptroller of the Currency as a byproduct of its regulatory role, but publication was irregular. 
Indeed, the Federal Reserve's adherence to the real bills doctrine - which counseled against active monetary management 
in  favor  of  supplying  money  only  as  required  to  meet  "the  needs  of  trade"  -  gave  the  new  institution  little  reason  to  pay 
attention to changes in the money stock. See Humphrey (1986) for a history of the real bills doctrine. The constraints of the 
gold standard also restricted (without entirely precluding) active monetary management by the Federal Reserve. 
In the second edition of his book, Currie (1935) wrote: "The achievement of desirable objectives ... rests entirely upon the 
effectiveness of control. The achievement, for example, of the objective of a price level varying inversely with the productive 
efficiency  of  society  demands  a  highly  energetic  central  banking  policy  and  a  high  degree  of  effectiveness  of  monetary 
control... Even for the achievement of the more modest objective of lessening business fluctuations by monetary means, the 
degree of control of the central bank is of paramount importance." (pp. 3-4). 

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_x000C_statistics. In 1939, the Federal Reserve began a project to bring together the available historical data 
on banking and money. This effort culminated in 1943 with the publication of Banking and Monetary 
Statistics,  which  included  annual  figures  on  demand  and  time  deposits  from  1892  and  on  currency 
from 1860. 
Academic  interest  in  monetary  aggregates  increased  after  World  War  II.  Milton  Friedman's  volume 
Studies  in  the  Quantity  Theory  of  Money,  which  contained  Phillip  Cagan's  work  on  money  and 
hyperinflation, appeared in 1956, followed in 1960 by Friedman's  A Program for Monetary Stability, 
which  advocated  that  monetary  policy  engineer  a  constant  growth  rate  for  the  money  stock. 
Measurement efforts also flourished. In 1960, William J. Abbott of the Federal Reserve Bank of St. 
Louis  led  a  project  that  resulted  in  a  revamping  of  the  Fed's  money  supply  statistics,  which  were 
subsequently published semimonthly.5 Even in those early years, however, financial innovation posed 
problems  for  monetary  measurement,  as  banks  introduced  new  types  of  accounts  that  blurred  the 
distinction  between  transaction  deposits  and  other  types  of  deposits.  To  accommodate  these 
innovations, alternative definitions of  money were created;  by 1971,  the  Federal Reserve published 
data for five definitions of money, denoted M1 through M5.6  
During the early years of monetary measurement, policymakers groped for ways to use the new data.7 
However, during the 1960s and 1970s, as researchers and policymakers struggled to understand the 
sharp  increase  in  inflation,  the  view  that  nominal  aggregates  (including  credit  as  well  as  monetary 
aggregates) are closely linked to spending growth and inflation gained ground. In 1966, the Federal 
Open Market Committee (FOMC) began to add a proviso to its policy directives that bank credit growth 
should not deviate significantly from projections; a similar proviso about money growth was added in 
1970.  In  1974,  the  FOMC  began  to  specify  "ranges  of  tolerance"  for  the  growth  of  M1  and  for  the 
broader M2 monetary aggregate over the period that extended to the next meeting of the Committee.8  
In response to House Concurrent Resolution 133 in 1975, the Federal Reserve began to report annual 
target growth ranges, 2 to 3 percentage points wide, for M1, M2, a still broader aggregate M3, and 
bank credit in semiannual testimony before the Congress. In an amendment to the Federal Reserve 
Act in 1977, the Congress formalized the Federal Reserve's reporting of monetary targets by directing 
the  Board  to  "maintain  long  run  growth  of  monetary  and  credit  aggregates  ...  so  as  to  promote 
effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."9 
In practice, however, the adoption of targets for money and credit growth was evidently not effective in 
constraining policy or in reducing inflation, in part because the target was not routinely achieved.10  
The closest the Federal Reserve came to a "monetarist experiment" began in October 1979, when the 
FOMC under Chairman Paul Volcker adopted an operating procedure based on the management of 
non-borrowed reserves.11 The intent was to focus policy on controlling the growth of M1 and M2 and 
thereby to reduce inflation, which had been running at double-digit rates. As you know, the disinflation 

                                                      
5   Board of Governors of the Federal Reserve System (1960). 
6  

In 1971, M1 was currency and demand deposits at commercial banks. M2 was M1 plus commercial bank savings and small 
time deposits, and M3 was M2 plus deposits at mutual savings banks, savings and loans, and credit unions; data from the 
latter type of institution were available only monthly. M4 was M2 plus large time deposits, and M5 was M3 plus large time 
deposits.  Changes  in  definitions make  it  difficult  to  track  the  historical  development  of  the  various  monetary  aggregates. 
Approximately, the 2006 definition of M1 is equivalent to this older definition, the 2006 definition of M2 is equivalent to the 
older definition of M3, and the definition of M3 at its date of last publication was equivalent to the older definition of M5. M4 
and M5 were dropped in a 1980 redefinition of the monetary aggregates. See Board of Governors of the Federal Reserve 
System (1976), pp. 10-11 and Anderson and Kavajecz (1994). 

7   For instance, in late 1959 and early 1960, money growth declined as other economic indicators rose. The minutes of the 
December  1959  FOMC  meeting  report  Chairman  Martin  as  saying,  "I  am  unable  to  make  heads  or  tails  of  the  money 
supply," but those of the February 1960 meeting record his comment that "the System ought to be looking at the growth of 
the money supply." For further discussion, see Bremner (2004), pp. 141-142. 

8   M2 now includes currency and demand deposits (the components of M1) plus time deposits, savings deposits, and noninstitutional money market funds. 

9   Board of Governors of the Federal Reserve System (1998), 1-017 
10   Monetarists criticized the use of multiple targets, rather than a single objective. Another object of criticism was "base drift," a 
set of practices that had the effect of re-setting the base from which money growth targets were calculated when the growth 
of one or more monetary aggregates exceeded the upper end of the Federal Reserve's target range. 

11   Whether the Federal Reserve's policies under Chairman Volcker were "truly" monetarist was a much-debated question at 

the time. 

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_x000C_effort was successful and ushered in the low-inflation regime that the United States has enjoyed since. 
However, the Federal Reserve discontinued the procedure based on non-borrowed reserves in 1982. 
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 that time, although policymakers continue to use monetary 
data as a source of information about the state of the economy. 
Why have monetary aggregates not been more influential in U.S. monetary policymaking, despite the 
strong theoretical presumption that money growth should be linked to growth in nominal aggregates 
and to inflation? In practice, the difficulty has been that, in the United States, deregulation, financial 
innovation,  and  other  factors  have  led  to  recurrent  instability  in  the  relationships  between  various 
monetary  aggregates  and  other  nominal  variables.  For  example,  in  the  mid-1970s,  just  when  the 
FOMC  began  to  specify  money  growth  targets,  econometric  estimates  of  M1  money  demand 
relationships began to break down, predicting faster money growth than was actually observed. This 
breakdown  -  dubbed  "the  case  of  the  missing  money"  by  Princeton  economist  Stephen  Goldfeld 
(1976)  -  significantly  complicated  the  selection  of  appropriate  targets  for  money  growth.  Similar 
problems arose in the early 1980s - the period of the Volcker experiment - when the introduction of 
new  types  of  bank  accounts  again  made  M1  money  demand  difficult  to  predict.12  Attempts  to  find 
stable  relationships  between  M1  growth  and  growth  in  other  nominal  quantities  were  unsuccessful, 
and formal growth rate targets for M1 were discontinued in 1987. 
Problems with the narrow monetary aggregate M1 in the 1970s and 1980s led to increased interest at 
the Federal Reserve in the 1980s in broader aggregates such as M2. Econometric methods were also 
refined  to  improve  estimation  and  to  accommodate  more-complex  dynamics  in  money  demand 
equations. For example, at a 1988 conference at the Federal Reserve Board, George Moore, Richard 
Porter,  and  David  Small  presented  a  new  set  of  M2  money  demand  models  based  on  an  "errorcorrection"  specification,  which  allowed  for  transitory  deviations  from  stable  long-run  relationships 
(Moore, Porter, and Small, 1990). One of these models, known as the "conference aggregate" model, 
remains  in  use  at  the  Board  today.  About  the  same  time,  Board  staff  developed  the  so-called 
P* (P-star) model, based on M2, which used the quantity theory of money and estimates of long-run 
potential output and velocity (the ratio of nominal income to money) to predict long-run inflation trends. 
The  P*  model  received  considerable  attention  both  within  and  outside  the  System;  indeed,  a 
description of the model was featured in a front-page article in the New York Times.13  
Unfortunately, over the years the stability of the economic relationships based on the M2 monetary 
aggregate has also come into question. One such episode occurred in the early 1990s, when M2 grew 
much more slowly than the models predicted. Indeed, the discrepancy between actual and predicted 
money  growth  was  sufficiently  large  that  the  P*  model,  if  not  subjected  to  judgmental  adjustments, 
would  have  predicted  deflation  for  1991  and  1992.  Experiences  like  this  one  led  the  FOMC  to 
discontinue  setting  target  ranges  for  M2  and  other  aggregates  after  the  statutory  requirement  for 
reporting such ranges lapsed in 2000. 
As I have already suggested, the rapid pace of financial innovation in the United States has been an 
important  reason  for  the  instability  of  the  relationships  between  monetary  aggregates  and  other 
macroeconomic  variables.14  In  response  to  regulatory  changes  and  technological  progress,  U.S. 
banks have created new kinds  of accounts and added  features  to  existing  accounts.  More  broadly, 
payments  technologies  and  practices  have  changed  substantially  over  the  past  few  decades,  and 
innovations  (such  as  Internet  banking) continue.  As a  result,  patterns  of  usage  of  different  types  of 
transactions accounts have at times shifted rapidly and unpredictably. 
Various special factors have also contributed to the observed instability. For example, between onehalf and two-thirds of U.S. currency is held abroad. As a consequence, cross-border currency flows, 
which can be estimated only imprecisely, may lead to sharp changes in currency outstanding and in 
the monetary base that are largely unrelated to domestic conditions.15,16

                                                      
12   The new accounts included negotiable-order-of-withdrawal (NOW) accounts and money market deposit accounts. 
13   Hallman, Porter, and Small (1991) and Kilborn (1989). 
14   Another possible explanation for this instability is the Goodhart-Lucas law, which says that any empirical relationship that is 
exploited for policy purposes will tend to break down. This law probably has less applicability in the United States than in 
some  other  countries,  as  the  Federal  Reserve  has  not  systematically  exploited  the  relationships  of  money  to  output  or 
inflation, except perhaps to a degree in 1979-82. 

15   For a recent summary, see U.S. Department of the Treasury (2006).  

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_x000C_The  Board  staff  continues  to  devote  considerable  effort  to  modeling  and  forecasting  velocity  and 
money  demand.  The  standard  model  of  money  demand,  which  relates  money  held  to  measures  of 
income  and  opportunity  cost,  has  been  extended  to  include  alternative  measures  of  money  and  its 
determinants, to accommodate special factors and structural breaks, and to allow for complex dynamic 
behavior of the money stock.17 Forecasts of money growth are based on expert judgment with input 
from various estimated models and with knowledge of special factors that are expected to be relevant. 
Unfortunately,  forecast  errors  for  money  growth  are  often  significant,  and  the  empirical  relationship 
between money growth and variables such as inflation and nominal output growth has continued to be 
unstable at times.18  
Despite  these  difficulties,  the Federal  Reserve will  continue  to  monitor  and  analyze  the  behavior  of 
money.  Although  a  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. Attention to money growth is thus sensible as part of the eclectic modeling 
and forecasting framework used by the U.S. central bank.  

References 
Anderson,  Richard  G.  and  Kenneth  A.  Kavajecz  (1994).  "A  Historical  Perspective  on  the  Federal 
Reserve's  Monetary  Aggregates:  Definition,  Construction  and  Targeting  (PDF  7.4  MB),"  Federal 
Reserve Bank of St. Louis Review, March/April, pp. 1-31.  
Board  of  Governors  of  the  Federal  Reserve  System  (1943).  Banking  and  Monetary  Statistics, 
1914-1941. Washington: Board of Governors of the Federal Reserve System. 
 -  -  -  -  -  (1960). "A New Measure of the Money Supply," Federal Reserve Bulletin, vol. 46 (October), 
pp.. 102-23. 
 -  -  -  -  -  (1976). Banking and Monetary Statistics, 1941-1970. Washington: Board of Governors of 
the Federal Reserve System. 
 -  - - -  -  - (1998). Federal Reserve Act and Other Statutory Provisions Affecting the Federal Reserve 
System. Washington: Board of Governors of the Federal Reserve System. 
Bremner, Robert P. (2004). Chairman of the Fed: William McChesney Martin Jr. and the Creation of 
the American Financial System. New Haven: Yale University Press. 
Carpenter, Seth and Joe Lange (2003). "Money Demand and Equity Markets." Federal Reserve Board 
Finance and Economics Discussion Series, 2003-3. Washington: Board of Governors of the Federal 
Reserve System, February. 
Currie, Lauchlin (1935). The Supply and Control of Money in the United States, 2nd ed. Cambridge: 
Harvard University Press. 
 -  -  -  -  - -, ed. (1956). Studies in the Quantity Theory of Money. Chicago: University of Chicago 
Press. 
Friedman, Milton (1960). A Program for Monetary Stability. New York: Fordham University Press. 
Friedman, Milton and Anna J. Schwartz. (1963). A Monetary History of the United States, 1867-1960. 
Princeton: Princeton University Press. 

                                                                                                                                                                      
16   As  another  example,  U.S.  regulations  require  servicers  of  mortgage-backed  securities  to  hold  mortgage  prepayments  in 
deposits counted as part of M2 before disbursing the funds to investors. A wave of mortgage refinancing and the resulting 
prepayments can thus have significant effects on M2 growth that are only weakly related to overall economic activity. See 
O'Brien (2005) for more discussion. 

17   See Judson and Carpenter (2006) for a summary. A special factor that helps to explain some episodes of variable money 

demand is stock market volatility (Carpenter and Lange, 2003). 

18   A  recent  example  of  instability  occurred  in  the  fourth  quarter  of  2003,  when  M2  shrank  at  the  most  rapid  rate  since  the 
beginning of modern data collection in 1959 without any evident effects on prices or nominal spending. Subsequent analysis 
has explained part of the decline in M2 (the transfer of liquid funds into a recovering stock market was one possible cause), 
and data revisions have eliminated an additional portion of the decline, but much of the drop remains unexplained even well 
after the fact. 

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_x000C_Goldfeld,  Stephen  M.  (1976).  "The  Case  of  the  Missing  Money."  Brookings  Papers  on  Economic 
Activity, 3:1976, pp. 683-739. 
Hallman, Jeffrey J., Richard D. Porter and David H. Small (1991). "Is the Price Level Tied to the M2 
Monetary Aggregate in the Long Run?" American Economic Review, 81(September), pp. 841-858. 
Humphrey,  Thomas  M.  (1986).  "The  Real  Bills  Doctrine  (PDF  1.2  MB),"  in  Thomas  M.  Humphrey, 
Essays on Inflation. Richmond: Federal Reserve Bank of Richmond. 
Judson,  Ruth  and  Seth  Carpenter  (2006).  "Modeling  Demand  for  M2:  A  Practical  Approach," 
unpublished  manuscript,  Board  of  Governors  of  the  Federal  Reserve  System,  Division  of  Monetary 
Affairs, October. 
Kilborn, Peter T. (1989). "Can Inflation Be Predicted? Federal Reserve Sees a Way," New York Times, 
June 13. 
Mankiw, N. Gregory and Jeffrey A. Miron (1986). "The Changing Behavior of the Term Structure of 
Interest Rates," Quarterly Journal of Economics, 101(2), pp. 211-228. 
Meltzer, Allan H. (2003). A History of the Federal Reserve. Volume 1: 1913-1951. Chicago: University 
of Chicago Press. 
Moore,  George  R.,  Richard  D.  Porter,  and  David  H.  Small  (1990).  "Modeling  the  Disaggregated 
Demands for M2 and M1: The U.S. Experience in the 1980s," in Peter Hooper et. al., eds., Financial 
Sectors in Open Economies: Empirical Analysis and Policy Issues. Washington: Board of Governors of 
the Federal Reserve System, pp. 21-105. 
O'Brien, Yueh-Yun C. (2005). "The Effects of Mortgage Prepayments on M2." Federal Reserve Board 
Finance and Economics Discussion Series, 2005-43. 
U.S.  Department  of  the  Treasury  (2006).  The  Use  and  Counterfeiting  of  United  States  Currency 
Abroad, Part 3 (PDF 601 KB). Washington: Department of the Treasury. 

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