By Anna Bernasek
Sunday, October 30, 2005
Few figures in public life succeed in maintaining both their stature and popularity over a long period of time. That's what makes Alan Greenspan such a tough act to follow. In his 18 years as chairman of the Federal Reserve, Greenspan has occasionally drawn criticism, but no one disputes his technical prowess or sniffs at his track record of low inflation and steady, almost uninterrupted growth.
Enter Ben S. Bernanke, President Bush's nominee to take Greenspan's place when his term ends at the end of January. Ushered before the media last Monday, Bernanke pledged "continuity" with the departing prince of monetary policy. That was reassuring to many. Despite their deep divisions, both Democrats and Republicans think that more of the same would be just fine.
But more of the same what? Bernanke can't pursue exactly the same policies as Greenspan did even if he wants to. The economy is a moving target, and policies can't just stand still.
If continuity means delivering the same results, that's even harder to promise. Greenspan's success has changed our expectations of the Fed. It's not enough to keep inflation low. We want the Fed to deliver it all: full employment, sustained economic growth, low interest rates and a strong stock market. It's as if we've come to assume the Fed controls the economy.
But it doesn't. For all its powers -- the power to set short-term interest rates and to print money, just to name two -- the Fed can only indirectly influence what happens in the economy as a whole. That's because the collective power of other independent players -- the rest of government, the private sector and foreign trading partners -- dwarfs even the Federal Reserve system. The Fed is a big player, but only one among many.
So how, exactly, did Greenspan convince so many people that he essentially "runs" the economy? What has been the essence of his tenure at the Fed?
From the time of his appointment by President Ronald Reagan in August 1987, Greenspan recognized that his image was critical. By carefully molding it, he could gain a degree of influence over lawmakers and bond markets. That in turn would enable him to nudge politicians and bond traders in ways that served his ends. So Greenspan crafted his public statements to persuade the world of his deep knowledge and vigilance about the economy. He moved with deliberation and spoke with a mesmerizing, yet strangely soothing, lack of clarity.
Greenspan did, however, make one thing clear: the need to combat inflation. He realized that he needed to establish his credibility on this front. Soon after his appointment, the Fed raised interest rates by half a percentage point and sent a message about his determination to tame price increases. He understood that an unhappy bond market could undo a Fed chairman and that the economy would suffer the consequences. So he never wavered on this point.
He also picked his battles. He avoided taking any action to pop the stock market bubble in the 1990s or the real estate bubble of the past couple of years, limiting himself to noting the "irrational exuberance" in the 1990s or "froth" in housing markets. But when the occasion warranted, he took risks -- and they paid off. After the 1987 stock market crash, a major test of his leadership in the early days of his tenure, he pumped liquidity into the markets to prevent a run on financial institutions and keep markets functioning. During the 1990s "productivity miracle" he kept interest rates low and the economy did not overheat. The public applauded and the traders of Wall Street believed they recognized a kindred talent.
Indeed Greenspan pulled off the rare feat of balancing the three goals spelled out in the 1913 law that created the Federal Reserve: "maximum employment," "stable prices" and "moderate long-term interest rates." In other words, jobs, low inflation and growth.
On the surface, Bernanke seems like a reasonable candidate to step into Greenspan's place. There is, after all, no strict rsum requirement for the job. Past chairmen have included a former stockbroker, bankers, a business executive, a government servant and a consultant. One, Arthur Burns, earned a PhD in economics as a young man. (Greenspan also received a doctorate, but it was more of an honorary degree granted after he had served as the chairman of President Ford's Council of Economic Advisers.) So by comparison, Bernanke's expertise -- built on his M.I.T. degree in economics, Ivy League pedigree, academic research and experience as a Fed board member -- is indisputable.
But for Bernanke to deliver "continuity" with the Greenspan era is not just a matter of technical knowledge. It means, above all, establishing his own stature and, perhaps in the post-Greenspan era, celebrity as well.
The first test will be his credibility on inflation. Last week, the White House, besieged by problems over its failed nominee to the Supreme Court, may have been focused on Bernanke's ability to win confirmation from the Senate, but the vote that ultimately matters more will be the one cast by the bond markets. Inflation will be their litmus test. Bond traders are already scouring Bernanke's record for evidence one way or the other. His nine-sentence statement on Monday did little to enlighten them. The bond market reacted by inching rates higher.
What's more, the former Princeton economics professor is currently the chairman of the president's Council of Economic Advisers. And while his White House stint has been short enough to keep him from having to answer for Bush's controversial tax cuts or big spending plans, he must still clearly establish his independence.
There is an important philosophical difference between Greenspan and Bernanke. Bernanke is a proponent of greater openness in Fed policy. He believes that's appropriate for a government institution in a democracy; it can reduce uncertainty about Fed thinking, and thus help economic players to plan. In contrast, Greenspan used ambiguity to enhance his mystique and, at times, used uncertainty as a threat of action.
As a democratic ideal, clear and visible economic rules are something to admire. But Greenspan's effective use of ambiguity provides a vital lesson in how the real world works. Transparency might not look so attractive if the public sees an institution run by unelected officials decide whether to put half a million jobs in jeopardy in order to shave a bit off the inflation rate.
Bernanke also favors "inflation targeting," an intellectual offspring of his belief in openness. Where Greenspan would answer a question about inflation with an intentionally vague but reassuring statement, Bernanke would prefer a clear and publicly announced inflation goal. Bernanke's concept boils down to setting the monetary dials to achieve a predetermined inflation rate. Yet perhaps because Bernanke has in the past qualified his message by saying he favors "flexible" inflation targets, bond traders need to hear more.
Given Bernanke's background, the fight against inflation is likely to remain primary. He studied economics during the 1970s, when oil prices soared and drove up inflation, and not even price controls could help. During the quarter century since August 1979, when Paul Volcker became Fed chairman, the story of the central bank has been its struggle to reestablish and maintain steadfastness on fighting inflation.
Bernanke understands this in theory. "Central bankers have long recognized at some level that the credibility of their pronouncements matters," Bernanke said in a speech a year ago. "I think it is fair to say, however, that in the late 1960s and 1970s, as the U.S. inflation crisis was building, economists and policymakers did not fully understand or appreciate the determinants of credibility and its link to policy outcomes."
He'll get a chance to try it in practice. Now, just as Bernanke arrives, the economic skies look ominous again. The stars aligned so neatly in the 1990s are moving. Higher oil prices are pushing up inflation while war costs and mounting budget deficits fuel inflation and threaten to drive up interest rates. Enormous foreign debts threaten to destabilize the dollar. And rising interest rates are taking a toll on the overblown housing market as well as consumer spending.
How Bernanke will approach all this is yet to be seen. After all, the former Princeton prof is a different man at a different time. The challenge for Bernanke is to make that difference count in his favor -- and in ours.
Author's e-mail: firstname.lastname@example.org
Anna Bernasek is a writer on economics and financial issues based in New York.