The Education of Ben Bernanke
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Correction Appended
Ben Bernanke’s first exposure to monetary policy was reading the works of Milton Friedman, the Nobel laureate. That was 30 years ago, when Bernanke was a graduate student at M.I.T., and he has been studying central banking ever since. By the time President Bush nominated him to run the Federal Reserve, at the end of 2005, Bernanke knew more about central banking than any economist alive. On virtually every topic of significance — how to prevent deflationary panics, for instance, or to gauge the effect of Fed moves on stock-market prices — Bernanke wrote one of the seminal papers. He championed ideas for improving communications between the Fed — whose previous chairman, Alan Greenspan, spoke in riddles — and the public, believing that clearer guidance about the Fed’s aims would help the economy run more smoothly. And having devoted much of his career to studying the causes of the Great Depression, Bernanke was the academic expert on how to prevent financial crises from spinning out of control and threatening the general economy. One line from his “Essays on the Great Depression” sounds especially prescient today: “To the extent that bank panics interfere with normal flows of credit, they may affect the performance of the real economy.”
The headquarters of the Federal Reserve, in Washington.
Bernanke, who came to the job with a refreshing humility — a desire to be less an oracle like Greenspan than a plain-speaking technocrat —faces exactly this sort of crisis now. Ever since last summer, a meltdown in financial markets has led to daunting losses in the banking industry and throughout Wall Street. Despite having written extensively on how to deal with such episodes, Bernanke has thus far been unable to reinstill a sense of confidence. His faith in modern forecasting models notwithstanding, he failed to foresee that the sudden rise in homeowner defaults, which triggered the crisis, would have such far-reaching effects. And the monetary medicine that he has prescribed, including some of the very tools that he lovingly detailed in his research, have yet to produce a turnaround.
At the same time, Bernanke’s attempt to improve the way the Fed communicates has misfired and often left investors confused, partly because he has repeatedly shifted course over the future direction of interest rates. His hero, Milton Friedman, is said to have warned against an indecisive Fed acting like a “fool in the shower” fumbling with first the hot water and then the cold. Bernanke has gotten close. Perhaps worst of all, he has failed to persuade investors that the Federal Reserve, which was formed in 1913 for the very purpose of halting market panics, is up to the job. “Bernanke is seriously behind the curve,” says David Rosenberg, chief North American economist for Merrill Lynch, one of many critics who maintain that the Fed has not responded to the crisis with sufficient vigor.
For Bernanke, who is now 54, it has been an education unlike any at M.I.T. And yet there is a case to be made that he has made many more right moves than wrong ones. The current crisis is a hangover from a half-decade of heady speculation in both housing and home mortgages and does not necessarily admit to a speedy fix. Moreover, it has fallen into Bernanke’s lap just as oil prices have spiked to a record $100 a barrel, the dollar has hit an all-time low against the euro and unemployment has ticked upward. None other than Alan Greenspan has said that constellation of problems facing Bernanke is tougher than anything he experienced in the 18 years that he held the job.
Many observers, including Lawrence Summers, the former Treasury secretary, as well as a group of bearish stock traders, say the United States may already be sinking into a recession. The rise in unemployment reported two weeks ago stoked those fears. The White House has started talking about proposing relief. And just recently, Bernanke sent the clearest signal yet that the 17-member Federal Open Market Committee (which governs the Fed’s interest-rate policy, and over which Bernanke presides) would cut interest rates when it meets at the end of the month. In a speech, Bernanke warned that “the downside risks to growth have become more pronounced,” a gloomier assessment of the economy than he had given previously.
Bernanke also has strong reasons to worry, however, about easing rates too much. Inflation has failed to fall as the Fed expected. (In fact, lately it has been rising.) Also, lower interest rates induce foreigners to switch out of dollar-denominated investments like Treasuries and into currencies with higher yields. Thus, any rate cut would tend to escalate the stampede out of the dollar.
Perhaps the last Fed chief to face such a difficult one-two punch of inflation and slowing growth was Arthur Burns, who was also the last academic to hold the job. President Richard Nixon, concerned that high unemployment could cost him re-election in 1972, told Burns to concentrate on revving up the economy. “No one ever lost an election on account of inflation,” Nixon confidently told him. Burns did as he was directed. An eventual result was runaway inflation and, for Burns, a legacy of failure.
Bernanke is aware that he holds the same potential for influence as Burns — which is to say he has a profound ability to affect the political landscape this year. Polls show that the economy is now the most important issue to voters in the presidential election (more important even than the war). A recession would seem to be a clear repudiation of President Bush’s policies and, by extension, the Republican Party. Those who know Bernanke, however, say he is not motivated by politics. “He wants to be known as a great central banker,” says Mark Gertler, his close friend and an economics professor at New York University. “Those with the worst reputations are the ones who helped politicians.”
A wage-and-price spiral similar to that in the 1970s would not only be a political nightmare for the Republicans, it would also be a crushing blow to Bernanke’s reputation as a Fed chief. And with oil and food prices going through the roof, inflation is already a worry. The consumer price index surged 4.3 percent over the past 12 months — more than twice the inflation rate that Bernanke has delineated as the upper bound of his comfort range. (The widely watched “core” rate of inflation, which does not include volatile food or energy prices, is not as high as the overall rate, but it, too, has edged higher than Bernanke would like.)
