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held by the banks and other depositories,

proved an adequate gauge of what the Fed is

either in their accounts at the Fed or as vault

doing: not during the Great Depression, when

cash, plus currency in circulation among the

rates were very low despite a collapsing money

general public. Between December 1986, 8

stock; not during the Great Inflation of the

months before Greenspan became Fed chair-

1970s, when rates were high despite an ex-

man, and December 2005, 19 years later, the

panding money stock; and not under Green-

monetary base rose by a hefty amount, from

span. A focus on interest rates not only

$248 billion to $802 billion (no figures are sea-

obscures the well-known distinction between

sonally adjusted). True, that doesn't sound like

nominal and real rates (nominal rates equal

a freeze. But virtually the whole increase was in

real rates plus expected inflation), it also

currency in circulation. (See Figure 1.) During

ignores the simple fact that interest rates can

that same time, total bank reserves grew from

change as a result of real factors involving sup-

$65 billion to $73 billion, for an average annu-

ply and demand.

al growth rate of a mere 0.65 percent. (These

The market ultimately determines interest

figures are unadjusted for any changes in

rates. Although central banks are big enough

reserve requirements and--unlike the some-

players in the loan market (and the quintes-

what misleading reserve totals reported by the

sential noise traders to boot) that they can

When all of these

Fed's board of governors--include all vault

push short-term rates up or down somewhat,

measures agree,

cash, clearing balances, and float.) In some

that ability is increasingly diminished, even for

years aggregate reserves rose; in others they fell,

a major central bank like the Fed, as globaliza-

it suggests that

with the major bump surrounding Y2K, when

tion integrates world financial markets. In

monetary policy

the accumulation of reserves by banks appears

defending his actions, Greenspan is correct in

was not all that

to have induced the Fed to accommodate a 40

attributing the unusually low interest rates

percent jump followed by a 30-percent drop.

early this decade mainly to a massive flow of

expansionary

Total reserves are also the one monetary mea-

savings from emerging Asian economies and

during 2002 and

elsewhere.5

sure that show a slight uptick into 2003, when

interest rates were down.7

A better, although now unfashionable, way

2003 under

During the same 19 years, currency in cir-

to judge monetary policy is to look at the mon-

Greenspan,

culation exploded faster than the monetary

etary measures: MZM, M2, M1, and the mone-

despite the low

base, at an annual rate of 7.54 percent. Prior to

tary base. Since 2001, the annual year-to-year

this explosion, currency was less than three

growth rate of MZM fell from over 20 percent

interest rates.

quarters of the total monetary base; today it is

to nearly 0 percent by 2006. During that same

over 90 percent. In a period when debit cards

time, M2 growth fell from over 10 percent to

and possibly ATMs were reducing currency

around 2 percent and M1 growth fell from over

demand, analysts were aware that all this new

10 percent to negative rates. Admittedly the

cash was not bulging in the wallets and purses

Fed's control over the broader monetary aggre-

of the average American. It was going abroad,

gates has become quite attenuated, for reasons

as a stable dollar evolved into an international

elucidated below. But even the year-to-year

currency. These growing foreign holdings of

annual growth rate of the monetary base since

Federal Reserve notes became an additional

2001 fell from 10 percent to below 5 percent in

factor increasing money demand and keeping

2006 and by June of 2008 was around 1.5 per-

U.S. inflation in check during the 1990s.8

cent, despite Ben S. Bernanke's alleged refla-

tion. When all of these measures agree, it sug-

Ideally we should adjust the monetary

gests that monetary policy was not all that

base and monetary aggregates downward, to

expansionary during 2002 and 2003 under

account for this drain abroad. Richard G.

Greenspan, despite the low interest rates.6

Anderson of the St. Louis Fed estimates that

the proportion of U.S. currency held abroad

The key to what was really going on is the

doubled between 1986 and 2005, from 25 to

monetary base, which the Federal Reserve

nearly 50 percent. Although his estimates

directly controls. The base consists of reserves

3