Bernanke, the Reluctant Revolutionary
Inside Ben Bernanke are two birds. The hawk hates inflation. The dove hates unemployment. On Aug. 1 the chairman of the Federal Reserve expressed his inner hawk. Despite the longest period of high unemployment since the Great Depression and inflation that’s actually below the Fed’s target, the rate-setting committee that he runs stood pat. At the end of a two-day meeting in Washington, the Federal Open Market Committee issued a statement acknowledging that the U.S. economy has “decelerated somewhat” but did not announce any fresh measures to stimulate growth. Doves were dismayed, if not surprised: “They really took a pass,” says University of Oregon economist Tim Duy, who runs the Fed Watch blog.
Bernanke is a reluctant revolutionary. After the global financial crisis of 2008-09 broke out, he pushed the nation’s central bank into radical actions not attempted since its founding in 1913, including near-zero interest rates and more than $1 trillion worth of bond buying. He did it because he saw no choice. Every step of the way, he looked the part of a quiet academic who would rather be working on his next paper for the Journal of Money, Credit and Banking.
With the global financial crisis over (for now), Bernanke is groping for a second act, like a monetary Bob Dylan who peaked too young. The actions demanded of him are less clear this time. The U.S. economy grew at an annual rate of just 1.5 percent in the second quarter of 2012. Chronically high unemployment is a human crisis every bit as real as the financial meltdown was. Should Bernanke respond at the next FOMC meeting in September by pushing monetary policy even deeper into uncharted territory? Or should he stand still to avoid the risk of inflating new bubbles and alienating the hawks on the committee? In short, which should Ben Bernanke be—acoustic or electric?
Few people can appreciate Bernanke’s dilemmas because they’ve never been at the helm of the central bank of the world’s largest economy. Someone who has is Alan Greenspan, who faced a similar challenge a decade ago in deciding how easy monetary policy should be and for how long. Hawkish critics still argue that Greenspan’s loose money inflated the disastrous housing bubble—a charge the former Fed chief says is “factually incorrect.” What Greenspan will concede is that the problems he faced are nothing compared to Bernanke’s. In an interview with Bloomberg Businessweek on July 27, Greenspan, now 86, said, “Ben Bernanke has a far more difficult job than I had.”
Bernanke, 58, was George W. Bush’s chief economic adviser in 2006 when he was appointed to head the Fed. The mild-mannered economist suddenly had immense power. President Barack Obama and House Speaker John Boehner (R-Ohio) are constrained by comparison because they can’t do anything without each other. Bernanke doesn’t need either to act. He has far more control over the Fed than Chief Justice John Roberts does over the Supreme Court. Unlike Roberts, a Fed chairman never votes on the losing side. The vote on Aug. 1 was 11-1, the only dissent coming from the hawkish Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, who objects to the Fed’s continuing intent to keep rates low through 2014.
Because of its demonstrated competence in crisis management, Bernanke’s Fed is being pulled into solving problems that the White House and Congress should be dealing with but aren’t. Housing? Under Bernanke the Fed has bought mortgage-backed securities to make loans cheaper and boost home sales. The fiscal cliff of spending cuts and tax hikes that threatens the economy at the start of 2013? The Fed’s loose money policies, by stimulating growth, are compensating at least partially for the chilling effect on hiring and investment that fears of the cliff are already causing.
It’s a lot, and Bernanke argues that too much is being put on the Fed’s shoulders. “Monetary policy is not a panacea,” he told the Joint Economic Committee of Congress on June 7. “It would be much better to have a broad-based policy effort addressing a whole variety of issues. I leave the details to Congress, which has considered many of these issues. I’d feel much more comfortable if Congress would take some of this burden from us and address those issues.”
Even on monetary policy, which is clearly within the Fed’s purview, Bernanke shies away from exercising all the power he has. Since his days as an economics professor at Princeton University, he has advocated group decision-making at the Federal Open Market Committee, which sets monetary policy. Greenspan spoke first at the eight-times-a-year meetings of the FOMC; Bernanke speaks last. He strives to demonstrate that the Fed is apolitical, mindful that Tea Party sympathizers in Congress would like to rein in the central bank.
Vincent Reinhart, who was the Fed’s director of monetary affairs from 2001 to 2007 and wrote papers with Bernanke, says the chairman is willing to force his will on the organization only in times of extreme crisis. And as serious as it is, the current period of slow growth and 8 percent unemployment may not count, at least in Bernanke’s view. “It would require the chairman to be willing to be more imperial and act with a democracy deficit,” Reinhart, now chief U.S. economist for Morgan Stanley, said before the FOMC announcement. Reinhart said he understands Bernanke’s hesitation, but added, “Maybe a little more imperial wouldn’t be a bad thing.”
It’s easy to underestimate or forget how revolutionary Bernanke’s Fed has already been. Since the end of 2008 it has kept the federal funds rate at zero to 0.25 percent, the lowest since the Fed began tracking the measure in 1954. After reaching the “zero lower bound” on overnight rates, the Fed turned to unprecedented actions, buying Treasuries and mortgage-backed securities in big quantities in an effort to bring down long-term interest rates and encourage borrowing by businesses and households.
Take this little quiz to see how much you know about Bernanke’s monetary policy derring-do. Have the central bank’s asset purchases since August 2008 increased banks’ lendable reserves by a) 25 percent, b) 50 percent, or c) 100 percent? It’s a trick question. The correct answer is d) 80,000 percent, from less than $2 billion before the financial crisis to around $1.5 trillion now.
Economists on both sides of the political aisle largely agree that Bernanke was right to throw a lifeline to banks and the shadow banking system at a time of maximum peril. “The response in the panic period of 2008 was important—the coordination with other countries, the provision of liquidity,” says John Taylor, an economist at the Hoover Institution.
That favorable consensus is long gone. Monetary hawks now accuse him of flooding the economy with money in a way that undermines the financial system and threatens hyperinflation. David Stockman, who was President Ronald Reagan’s budget director, advises investing in ABCD—for “anything Bernanke can’t destroy,” including gold, canned beans, bottled water, flashlight batteries, and maybe a mountain cabin.
To the hawks, the Fed’s drive to pump up banks’ lendable reserves has created a $1.5 trillion bomb with a short fuse. In ordinary times banks try to avoid carrying reserves—i.e., cash in their vaults plus their checking accounts at the Fed—above the required minimum. It’s more profitable to lend the money to customers. Loan demand is soft now, but hawks worry that when it recovers banks will massively increase lending, resulting in a burst of money creation that ignites inflation. Hence Stockman’s survivalist warning. Allan Meltzer, a Carnegie Mellon University economist who has studied the Fed since the 1950s, charges Bernanke with engineering “the lowest interest rates since Alexander Hamilton was a boy and excess reserves coming out the kazoo.” (Yes, he said kazoo.)
It’s not just hyperinflation that hawks such as Meltzer fear. Just as dangerous, they say, is “malinvestment”: money going to unproductive uses, as happened in the disastrous residential construction boom. Ronald McKinnon, a Stanford University economist, says low rates can keep alive “zombie” banks and their borrowers when it would be better for the economy to flush bad debt out of the system. The Fed is also shielding Congress from the consequences of the federal government’s fiscal irresponsibility, McKinnon says. Ordinarily the bond market vigilantes, alarmed by the prospect of uncontrolled deficits, would have pushed up America’s borrowing costs, says McKinnon, but they’ve been neutralized by the Fed’s commitment to keep long-term rates low at all costs. Foreign central banks, including China’s, have kept the dollar from collapsing by soaking up dollars that go abroad for higher yields, he says. In a forthcoming paper, McKinnon says zero interest rates are more “mutilating” than “stimulating.”
Bernanke lost credibility with the inflation-wary hawks when he supported Greenspan’s low-rate policies and failed to see the debt crisis brewing: In a 2007 speech he said, “Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market.”
By now the Fed chairman is used to being gored by hawks. What’s more surprising is the charge from doves that he is doing too little to boost growth because he’s caved in to inflationphobes and Republicans. “We have reached a point where the Fed is afraid to do its job, for fear of being accused of helping Obama,” economist Paul Krugman wrote in a New York Times blog post last month called “The Feckless Fed.”
The doves focus on the damage being done to the economy by prolonged high unemployment. Workers’ skills atrophy. Productivity suffers. “Failure to act aggressively now will lower the capacity of the economy for many years to come,” Charles Evans, president of the Federal Reserve Bank of Chicago, said in a June speech in New York.
Bernanke can’t ignore the doves for one reason: Unemployment is higher than the Fed’s own target and inflation is lower. The two criteria point in the same direction: Do more.
Fed watchers scrutinizing the Aug. 1 statement concluded that Bernanke is setting up expectations for some kind of action at the next FOMC meeting, Sept. 12-13. A small, easy step would be announcing an intent to keep rates superlow for another year, to the end of 2015. A bigger move would be buying more Treasury bonds and mortgage-backed securities to lower long-term rates.
Bolder, but less likely, would be to eliminate the 0.25 percent interest that the Fed is paying on banks’ reserves, which might induce them to lend more out. Princeton economist Alan Blinder, who was Fed vice chairman under Greenspan, has been lobbying FOMC voters to go even further and charge banks 0.25 percent a year for the privilege of keeping excess reserve balances. Evans of Chicago, the Fed’s strongest dove, would promise not to increase the federal funds rate until the unemployment rate falls below 7 percent, or inflation rises above 3 percent over the medium term. “I can’t tell you how often people look at me in abject horror” when he floats that idea, Evans said in June. As for an even more drastic remedy that has been floated—raising the inflation target to 4 percent from 2 percent—Bernanke calls it “very reckless.”
Alan Greenspan has made a point of not commenting on his successor’s policy. Yet from his elliptical, maple-trimmed office on Connecticut Avenue, just a mile from Fed headquarters, the former chairman has diagnosed what ails the U.S. economy: uncertainty. He says that by his calculations, the share of nonfinancial corporations’ cash flow that’s going into private fixed investment is the lowest in peacetime since 1935. And very little of that investment is going into structures, such as factories and other long-lived assets, which require the biggest leap of faith by businesses. Says Greenspan: “This is a wholly different phenomenon created by a degree of uncertainty that’s unprecedented since the ’30s.”
The uncertainty won’t subside, he says, until market prices are allowed to find their true bottom without government interference. “Preventing liquidation of an unbalanced market will leave you in tears,” says the ex-chairman.
Bernanke can hardly dispute the importance of uncertainty. His own doctoral thesis said, “Uncertainty is seen to retard investment independently of considerations of risk or expected return.”
Impressions matter. It would be a disaster for Bernanke to overreact to the slump and lose the hard-won confidence of the markets and businesses in the Fed’s commitment to a sound dollar. On the other hand, Bernanke would also damage the Fed’s credibility if he held his fire despite clear evidence that inflation is below the Fed’s target and unemployment is above it.
“It’s sort of damned if you do, damned if you don’t,” says Michael Feroli, chief U.S. economist of JPMorgan Chase. “They’re in a tough position.” Bernanke secured his reputation during the financial crisis. Temperamentally, he may prefer a cautious approach that won’t tempt the gods of inflation. But whether he likes it or not, Bernanke is the most powerful economic policymaker in Washington at a time when the country faces a once-in-a-generation challenge. Only the reticent Professor Bernanke can decide when it’s time to turn radical again.