(BLOOMBERG) – The Federal Reserve is now the subject of more political controversy than at any point since the beginning of the 1980s.

The debate centers on what the Washington Post calls its “ultra-easy” monetary policy: Is it hurting or helping the economy? Has the Fed already loosened so much that it has used up its ability to stimulate the economy?

It’s a heated debate, but its premise happens to be wrong. We don’t have loose money, and we haven’t during our entire economic slump. A big reason that slump has been so deep and long is that the Fed is keeping money tight: It’s not letting the money supply increase enough to keep current-dollar spending growing at its historical rate.

That view sounds crazy to a lot of people. They look at low interest rates, soaring commodities prices and an expanded money supply, and assume that these are clear indications of easy money. And sometimes these conditions do reflect monetary ease.

But not always. The late great Milton Friedman looked at Japan’s lost decade and grasped that its low interest rates were, counterintuitively, a sign of tight money: The Bank of Japan had choked the life out of the economy by keeping the money supply too low, and that’s what kept interest rates down.

Short-term moves in commodity prices are not reliable evidence of inflation, either. Otherwise we would have to conclude that we have loose money any time Asian consumption of precious metals increases, or there’s a disruption of the oil markets.

As for the money supply, its increase signifies looseness only if the demand for money balances stays constant. If the supply rises but demand rises even faster, then the central bank has, perhaps inadvertently, allowed money to tighten.

A Better Baseline

These are not just theoretical possibilities. The Fed of the early 1930s offers us history’s most disastrous example of extremely tight money, but at the time low interest rates and an expanded monetary base misled central bankers into thinking their policies were loose. By not sufficiently accommodating increased demand for money balances, the Fed allowed nominal spending to collapse.

You can’t figure out whether monetary policy is loose or tight, in short, without picking the right baseline against which to judge it. The baseline that makes the most sense at the moment can be found in the record of the so-called Great Moderation, from 1987 to 2007. During that time, Fed policies kept the size of the economy growing at a fairly stable 5 percent a year in current dollars. (Inflation averaged 2 percent, real growth 3 percent.) That stability, in turn, anchored expectations about how easy it would be to repay nominal debts.

Recession Reaction

By this measure, money was loose during the closing period of the Great Moderation, also known as the housing bubble: Nominal growth in gross domestic product was above trend. Since then, though, money has been tight. In 2008, the recession and the financial panic sent the demand for money balances sharply upward. (In other words, the “velocity” of money — the rate at which it changes hands — dropped.)

The Fed, partly because it was worried that a surge in commodity prices presaged future inflation, didn’t increase the money supply enough to accommodate that demand. Making matters worse, it instituted a policy of paying banks interest on reserves, which discourages lending and money creation.

The results are all around us. Instead of rising, inflation fell, and has stayed low. Nominal GDP fell faster than at any other point in the last six decades. To return to the pre-crisis trendline, nominal GDP would have to grow by more than 5 percent annually for a few years. Neither round of the Fed’s quantitative easing brought us close to that level. In per- capita terms, nominal GDP is actually below where it was at the start of the crisis.

A New Target

When nominal GDP falls below expectations, people find the burden of their nominal debts — such as mortgages — unexpectedly rising. Uncertainty about the economic outlook increases, and makes consumers and businesses more skittish than they otherwise would be.

Economics professor and blogger David Beckworth suggests that the Fed should abandon interest-rate targeting and instead announce that it will do whatever it takes — from further quantitative easing to throwing money out of a helicopter — to restore nominal GDP to trend.

If markets believe the Fed will follow through, expectations of the future path of nominal spending will adjust upward and that should, in turn, increase nominal spending levels right now. Part of that increase would take the form of an uptick in inflation — which markets currently expect to be extremely low for the next decade — but part of it would also be increased economic activity.

Ending the Fed’s tight-money policies need not punish savers, as is often alleged, because a healthy economic recovery should raise real returns. Conservatives are suspicious of any loosening because they think of it as a government intervention in the free market. But they are wrong. A central bank that keeps the supply of money too low is just as interventionist as one that keeps it too high.

There’s a strong case against central banking itself — against, that is, having a government agency with vast discretion over the money supply. But as long as we have one, it ought to set the best policy it can. And as long as we’re debating its conduct, we ought to be asking the right questions.

(Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review. The opinions expressed are his own.)

To contact the author of this article: Ramesh Ponnuru at rponnuru@bloomberg.net.