Business News
Key central bankers fall out over rates-setting methods
By DPA
Nov 11, 2006, 2:35 GMT

Frankfurt - Divisions emerged between the world's key central bankers Friday over the role played by the money supply in determining future inflationary trends and consequently the direction of interest rates.

While US Federal Reserve chief Ben Bernanke moved to downgrade the importance of money supply, his counterpart at the European Central Bank, Jean-Claude Trichet reinforced the view of the Frankfurt-based bank that the money supply was a major factor in its monetary policy deliberations.

Both were speaking at a meeting of central bankers in Frankfurt, with their remarks coming as the dollar fell against the euro on global forex markets after signs that China might consider rebalancing its reserves in the American currency.

A senior representative of the Bank of Japan also attended the conference, which was arranged by the ECB.

Speaking at the conference, Bernanke said: '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.'

In a sense, however, Bernanke's comments chime in with the views of other central banks and economists which have also tended to step back from money supply as an instrument for assisting in drawing up inflation projections.

For this part, Trichet told the conference that a pickup in credit growth as reflected in the money supply had been critical in the ECB's decision to launch a rate-hiking cycle in December.

He told the conference 'the continued expansion of money and credit through the course of 2005 gave an intensifying indication of increasing risks to medium and long-term price stability,' he told an ECB conference.

'Without our thorough monetary analysis, we could have been in danger of falling behind the curve,' he said.

But Bernanke did concede that money growth might offer important information about future economic developments.

Bernanke pointed to the fast-paced growth of financial innovation in US markets as well as the build-up in foreign holdings of the dollar as possible reasons for the instability of the links between money supply data and the economy.

However, the fed chairman's remarks came in the wake of comments to the conference by his counterpart at China's central bank, Zhou Xiaochuan, which raised the prospects of the Beijing monetary authorities winding back their big US dollar reserves as they switch to other currencies.

The result was to drive the dollar down against the euro with the common currency at one point during trading Friday edging its way towards the key 1.30 dollars mark.

Zhou told those attending the conference that diversification of its FX reserves would include different currencies and investment instruments.

Analysts said the remarks by the Chinese central bank chief added to the less-than-positive mood towards the greenback currently prevailing in financial markets.