Tuesday, July 21, 2009

Bernanke Explains His Exit Strategy for Neutralizing the Growth in Monetary Base

Fed chairman Ben Bernanke lays out in today's WSJ the methods the Fed plans to use for controlling the monetary base so that it doesn't result in massive money growth. He correctly points out the dangers of the current situation with huge reserves in the system and the necessity to neutralize these reserves before they cause a huge increase in money supply:

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.
This should put to rest, although I doubt it will, those who have been screaming about the growth in the monetary base. As I have regularly said, watch the actual money created M2 nsa and not the monetary base.

The money that gets into the system is the M2 nsa, not the monetary base. As Berrnanke notes:
... given the current economic conditions, banks have generally held their reserves as balances at the Fed.
That said, M2 nsa under Bernanke has been as about as stable as Britney Spears. There have been periods of 15% annualized M2 nsa growth, and periods of slow growth. Currently, Bernanke appears to be taking us for another dip in the stock market and economy as their is no growth in the economy. In fact, over the last three months, M2 nsa has actually declined.

Brace yourself. Any current positive news or upside activities in the economy or stock market are the result of Bernanke's previous 15% annualized money growth. Once this is finished working is way through the system, at present, there is no money behind it.

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