Ben S. Bernanke argued for 15 years that the Federal Reserve should announce a numerical inflation target. When he finally got his way in January, the victory allowed the central bank to elevate its other mandate: full employment.
By adopting a 2 percent inflation goal, the Fed chairman sought to cement the central bank’s hard-earned credibility for keeping prices low after a 30-year fight against inflation. Bernanke calculated that doing so would anchor expectations for price changes, giving policy makers greater freedom to unleash new stimulus targeted at creating jobs. So far, the move has worked: The Fed embarked on a third round of quantitative easing in September without unhinging inflation expectations.
Bernanke’s shift to emphasizing employment goals is one of the hallmarks in a grueling two-term chairmanship that spanned the worst financial crisis and recession since the Great Depression and a slow labor-market recovery that pinned joblessness above 8 percent for 43 months. The presidential campaign has put the Fed in transition as Republican candidate Mitt Romney said he’d replace Bernanke, though former colleagues doubt he will stay on, no matter who wins.
Bernanke has explicitly returned the U.S. central bank to the broader, more balanced goal that Franklin Roosevelt described in 1937 as seeking “the greatest attainable measure of economic well-being, the largest degree of economic security and stability” when the then-president inaugurated the Fed’s Beaux Arts-inspired Washington headquarters.
“This is a Federal Reserve that helped save the world,” said Frederic Mishkin, a Fed governor from 2006 to 2008 and now a professor of banking and financial institutions at Columbia Business School in New York. “Were there risks to doing so? Absolutely. But sometimes you have to take a tough stance, not knowing exactly what the right thing to do is.”
Some Fed chairmen are defined by crises and how they failed or met the challenge. Paul Volcker is remembered for his battle against inflation during his 1979 to 1987 tenure, when he allowed the federal funds effective rate to rise as high as 22 percent to tame annual price acceleration approaching 15 percent. Bernanke’s increased emphasis on job creation is a product of his era and its economic weakness, according to Federal Reserve Bank of New York President William C. Dudley.
The 58-year-old Fed chairman, who once wrote that an understanding of the Great Depression would be the “Holy Grail of macroeconomics,” served as a governor from 2002 to 2005 when the central bank neglected to take action to slow the housing bubble. He became chairman in 2006 and in March 2007 told the Joint Economic Committee of Congress that “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”
The 18-month recession began in December 2007, and in March 2008 Bernanke used the Fed’s balance sheet to buy up high-risk securities from Bear Stearns Cos. to save the firm from collapse, establishing the central bank’s role as the nation’s main rescue agent.
He shunned orthodoxy as the housing-finance bubble began to deflate and pushed the Fed to “the very edge of its lawful and implied powers,” Volcker said in a 2008 speech. Bernanke gave out more than $2 trillion in emergency aid through six loan programs, currency swaps with other central banks and the rescues of Bear Stearns and American International Group Inc. (AIG)
“It’s a little bit of an accident in history that this guy who did all of this work on the Great Depression got the chance to take the wheel,” Dudley said during an interview in his New York office.
The force with which Bernanke has attacked joblessness has distinguished him, Dudley said. By expanding the central bank’s balance sheet to a record of almost $3 trillion through asset- purchase programs and keeping the federal funds rate near zero for an unprecedented four years, Bernanke has established himself as history’s most bold and experimental Fed chairman in trying to spur growth.
“Bernanke’s legacy is in being very creative and aggressive in response to an adverse economic environment,” said Dudley, who is also vice chairman of the policy-setting Federal Open Market Committee. He has shown “it’s OK to be aggressive on monetary policy because there are long-run costs of not getting back to maximum sustainable employment quickly.”
Even after emergency lending programs were unwound, he continued to innovate, engaging in three rounds of outright bond purchases known as quantitative easing, aimed at lowering long- term yields with the benchmark rate stuck at zero.
The risks posed by the Fed chief’s policies -- including whether the central bank can withdraw its record accommodation before it sparks a surge in inflation -- may prove to be the test for Bernanke’s successor, as his second term ends in January 2014. The White House declines to comment on prospects for a third term, and Bernanke said at a Sept. 13 press conference that he doesn’t “have any decision or any information to give” on his personal plans.
The chances of Bernanke accepting a third term under Obama “are quite low,” said former Fed Vice Chairman Don Kohn, now a senior fellow at the Brookings Institution in Washington. “Eight years of this kind of pressure under the magnifying glass, taking difficult, difficult positions; he must be looking forward” to doing something else.
The potential for the unprecedented expansion of the Fed’s balance sheet to spark a rapid acceleration in prices has landed Bernanke, former chairman of Republican President George W. Bush’s Council of Economic Advisors, in his own party’s crosshairs.
“We’re only halfway through this experiment,” said Ethan Harris, co-head of global economics research at Bank of America Corp. in New York. “So far, the quantitative easing has probably been a small stimulus to the economy and has not created an inflation problem. So far, it’s a partial success. The question then becomes, how hard is it to exit?”
The Fed’s second round of asset purchases, dubbed QE2, ran from November 2010 through June 2011 and unleashed the worst political backlash against the U.S. central bank in three decades. Unlike the criticism Volcker faced, the arguments from lawmakers this time were for tighter monetary policy: Republicans from House Speaker John Boehner of Ohio to Representative Ron Paul of Texas warned that the measures risked inflation, and QE3, announced Sept. 13, immediately sparked renewed attacks.
The concern that Bernanke’s policies threaten price stability has led some Republicans to seek a change in the Federal Reserve Act that would restrict the Fed’s focus solely to that goal, stripping the central bank of its jobs mandate. The Sound Dollar Act -- introduced in March by Representative Kevin Brady of Texas, the Joint Economic Committee’s top Republican -- currently has 48 co-sponsors in the House.
“I hope we can move to a single mandate,” Senator Bob Corker, a Tennessee Republican on the Senate panel with Fed oversight authority, said in an interview Sept. 25. “We are going to continue to champion that.”
While Congress affirmed “maximum employment” as a goal in the Federal Reserve Act in the 1970s, the phrase didn’t appear in an FOMC policy statement until September 2010, according to research by the Federal Reserve Bank of St. Louis. The more explicit reference to the dual mandate is notable because it was ignored for so long by Bernanke’s predecessors, said Benjamin Friedman, an economist at Harvard University in Cambridge, Massachusetts, who has written extensively about central-bank goals.
While Alan Greenspan pursued policies that paid heed to employment -- joblessness fell to 3.8 percent in April 2000, a 30-year low -- his Fed spoke and acted as if its main job was fighting inflation. The FOMC statement from May 16, 2000, described central bankers’ goals as “price stability and sustainable economic growth,” with no mention of employment or labor.
“They are pursuing both objectives, but they were always trying to pretend that they weren’t” as they tried to bolster their inflation-fighting credibility, said Friedman, who added he never expected Bernanke to be the chairman who gave full- throated expression to the maximum-employment goal both in the statement and in policy.
As an economics professor, Bernanke’s writings advocated constrained discretion and transparency in central banking, while acknowledging its limits.
“When monetary-policy makers set a low rate of inflation as their primary long-run goal, to some significant extent they are simply accepting the reality of what monetary policy can do,” he wrote with three other economists in a 1999 book on inflation targeting.
When Fed officials adopted their inflation goal in January, they didn’t add one for joblessness, saying it would “not be appropriate” to do so because the elements that determine maximum employment “change over time and may not be directly measurable.”
The inability to pinpoint a jobs target, or even potentially influence hiring directly, didn’t stop Bernanke from issuing in September one of the most aggressive statements in Fed history. In addition to pledging to buy $40 billion of mortgage-backed securities a month, the central bank said it doesn’t plan to raise interest rates until at least mid-2015 and policy will remain accommodative “for a considerable time,” even after the economy strengthens. The Fed echoed that statement after its Oct. 23-24 meeting.
“His legacy will be to show that the Fed can be a very effective public-policy instrument and that the dual mandate in fact is meaningful,” said Representative Barney Frank, the ranking Democrat on the House Financial Services Committee. “He has always been aware of that mandate.”
Some Fed officials say the recent aim of lowering unemployment suggests the central bank has more control than is possible.
“You don’t want to overpromise that you can do something about it when really you can’t do anything about it, at least in the medium- to long- term,” St. Louis Fed President James Bullard said in an interview. “We started putting more references in to employment, and I guess I don’t object to those references, but I think that they raise a risk that we could be misunderstood as saying that we’re directly responsible for the outcome in labor markets.”
This isn’t the first time Bernanke’s policies have proved controversial within the FOMC. Last year, three Fed bank presidents dissented for the first time since 1992 as the FOMC took the unprecedented step of tying the horizon for near-zero interest rates to a calendar date.
Richmond Fed President Jeffrey Lacker also dissented against the September decision to start the Fed’s third round of bond buying, and Dallas Fed President Richard Fisher, who doesn’t vote on policy this year, said in an interview with Bloomberg Radio that he “personally questioned the efficacy of what we have done,” referring to the purchases.
Charles Plosser of Philadelphia, who also doesn’t vote in 2012, said the new program probably won’t boost growth and may jeopardize the Fed’s credibility.
Unlike his predecessor Greenspan, Bernanke has encouraged more open debate and dissent as he deliberately sought to shift some of the power that resided in the chairman’s office to his colleagues.
“Bernanke came in wanting to change that, to some extent, to empower the committee more,” Kohn said. Even so, “he is still a strong leader.”
The chairman’s open-mindedness is one of his defining characteristics, according to Dudley. Bernanke’s eagerness for discussion in part reflects the former Princeton University professor’s intellectual confidence, he said.
“He’s willing to throw out novel, seemingly crazy ideas; some of them crash and burn as we review and discuss them,” Dudley said. “That’s very unusual for a senior policy maker.”
Having made the FOMC more democratic, vocal and open means that if Bernanke does leave the Fed in 2014, it will be difficult for an autocratic leader to seize control of policy, according to Roberto Perli, a former economist for the Fed’s Division of Monetary Affairs and a managing director at International Strategy & Investment Group in Washington.
Bernanke’s efforts to increase transparency also have included holding regular press conferences, revealing policy makers’ interest-rate forecasts and announcing projections for economic growth, unemployment and inflation four times a year, compared with twice under Greenspan. These changes haven’t always streamlined the Fed’s message.
“It’s been an odd experience,” said Bank of America’s Harris, a former New York Fed researcher and author of “Ben Bernanke’s Fed: The Federal Reserve After Greenspan.” While “the Fed certainly talks a lot more and gives a lot more information, it’s fairly confusing following the Fed because they’re in such an experimental world, and the markets keep on having to relearn the rules.”
Bernanke’s experimentation and activism occasionally have crossed boundaries previously drawn by the Fed and left some unresolved issues. His crisis-fighting contradicted a joint agreement published by the Fed and Treasury in March 2009 that “actions taken by the Federal Reserve should also aim to improve financial or credit conditions broadly, not to allocate credit to narrowly defined sectors or classes of borrowers.”
Lacker dissented in September when the U.S. central bank decided again to purchase mortgage-backed securities, saying such industry-targeting was “inappropriate,” according to Fed minutes.
“Apparently, the Fed does not want to get into the discussion of boundaries at all,” said Marvin Goodfriend, a former Richmond Fed policy adviser who is now a professor at Carnegie Mellon’s Tepper School of Business in Pittsburgh. “The risks are that there is a ratcheting up from chairman to chairman of Fed interventions and responsibilities and potential involvement in fiscal matters.”
One of the consequences of the Fed’s extraordinary stimulus is the perception that the central bank can ward off disaster or fix it when it occurs, according to some policy makers.
“A role the future Fed will have to wrestle with is how can we stabilize policy after we’ve taken such dramatic and unusual action?” Bullard said. “There’s kind of a re-centering of policy that has to occur over the next five or 10 years to get people to accept that the central bank is going to” return to more rule-like behavior.
Public expectations have been raised, not only for monetary policy but also for the Fed’s supervisory capabilities. Despite criticism that it failed to adequately regulate the nation’s biggest banks, the Fed’s oversight of financial risk was formalized in the 2010 Dodd Frank Act. Lawmakers placed the central bank in charge of setting capital, liquidity and risk- management standards for the largest financial institutions, and of assuming oversight for nonbank firms designated as systemic by an oversight council of regulators.
The Board’s supervisory and regulatory staff was budgeted to climb to 383 members this year from 258 in 2007, while these staffs at the reserve banks are projected to rise to 3,741 people from 2,657. Even with the increase in resources, the Fed may be set up to fail again in the eyes of the American people.
“I don’t think the expectation the public and the political system has for regulators’ and supervisors’ responsibilities is reasonable,” Lacker said in an interview. “We have been set up again to be scapegoats the next time something goes wrong,” and when something “blows up, somebody will want us to step in.”
For Bernanke, the Fed’s emergency actions during the financial crisis and its aggressive response to the slow recovery are rooted in his historical understanding of the institution. Congress created the Fed in 1913 to resolve recurring financial panics and expanded its mission to price stability and jobs. To do anything less in his eight years as chairman would not follow the law.
“History will have judged Ben Bernanke to have been an outstanding chairman who did what he had to do under extremely difficult circumstances,” Kohn said.
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