Bank Regulation as Monetary Policy: Lessons from the Great Recession

In this article, we depart from the consensus view by suggesting that growth rates of broad money are a better indication of the postcrisis stance of monetary policy in the United States than the federal funds rate. Viewed from the perspective of broad money-we prefer the unweighted "M4 minus" (hereafter, M4 -) aggregate compiled by the Center for Financial Stability - the stance of monetary policy has been relatively tight since the beginning of the credit crisis. Postcrisis legislation and changes to the international bank regulatory regime are primarily responsible for reduced broad money growth. Their combined effect has been to establish bank regulation as the primary determinant of monetary conditions, as opposed to a regime of central bank dominance or fiscal dominance. The Federal Reserve has been able to partially offset the monetary effects of these regulatory changes through quantitative easing (QE). But an unintended consequence of QE has been to divert attention from obstacles to money creation by the banking system. The pattern of bank lending that may be expected to prevail without large-scale support from the Fed's balance sheet has serious implications for any QE exit strategy.