Bullish on Bernanke
Turnaround Earns Him Praise from Wall Street to Capitol Hill

By Nell Henderson
Washington Post Staff Writer
Tuesday, January 30, 2007

The new chairman of the Federal Reserve got off to a rocky start last spring. Inflation was surging, the housing market was slumping, and Ben S. Bernanke's initial responses caused turmoil on Wall Street.

But a year into Bernanke's tenure, the picture has turned considerably brighter. Inflation is falling; unemployment is low; wages are rising; and the economy, despite continued problems in housing, is growing at a brisk clip. Bernanke is earning plaudits from Wall Street to Capitol Hill.

"His stewardship in the first year has to be applauded by markets, investors and other policymakers," said Robert DiClemente, chief U.S. economist at Citigroup Global Markets. "He was able to arrest inflation without killing the expansion. That's really the ultimate victory."

Added Sen. Kent Conrad (D-N.D.), chairman of the Senate Budget Committee: "I think he's doing his level best to manage monetary policy in a way that will accommodate growth."

Certainly, the Bernanke Fed remains a work in progress. He promised greater openness, but despite months of discussion, the central bank's arcane methods of communicating with the public have not changed much. And the chairman's skills as a leader remain untested by a financial crisis or serious conflict among members of the policymaking Federal Open Market Committee.

Nonetheless, it's clear Bernanke is hitting his stride, according to observers in business, academia and finance.

"His judgment has been good and his luck has held up," said Allan H. Meltzer, author of a two-volume history of the Fed. "People are beginning to accept his leadership."

Bernanke's biggest challenge over the past year was deciding how high to raise borrowing costs to keep inflation under control. He stumbled in April when he told Congress the Fed might pause in its series of interest-rate increases. Coming at a time when financial markets were growing jittery about rising prices, his words prompted many investors to think the central bank had gone soft on inflation.

He compounded the confusion by telling a television reporter the markets had misread him, a comment he later described as "a lapse in judgment."

Bernanke calmed the markets by declaring his determination to squelch inflation and by leading the Fed to raise its benchmark short-term interest rates to 5.25 percent in June, the highest level in more than five years.

The harder decision was when to stop. The new Fed chief and his colleagues knew by the summer that the economy was cooling. And they wanted to avoid raising interest rates too high for fear the housing market might fall so far as to drag the economy into a recession.

So they stopped at their August meeting, leaving the benchmark rate unchanged for the first time after 17 consecutive increases over two years.

Some critics in the markets declared that borrowing costs were still too low to subdue inflation, while others said the Fed had already raised rates too far.

But Bernanke and his colleagues have held the rate steady since. They are likely to leave the rate unchanged at the end of their meeting today and tomorrow, and to indicate they might increase the rate again if inflation does not continue to fall. Many analysts now predict the Fed will remain on hold through this year.

Some observers said Bernanke's cautiousness marked a break with Greenspan's practice of raising rates aggressively to head off inflation, then easing them a bit a few months later when it was clear the danger had receded.

"We can never know what Greenspan would have done, but in the past he overshot," said Diane Swonk, chief economist of Mesirow Financial. The Bernanke Fed, by contrast, is "very worried about overshooting."

The August meeting also marked a shift in central bank communications under Bernanke. For the first time in three years, the Fed chairman did not signal to the markets the likely outcome of a policymaking meeting beforehand.

Instead, Bernanke sought to shift the markets' attention further into the future, using his congressional testimony in July to highlight the Fed policymakers' forecast for the economy over the next 18 months or more. This outlook represents how the economy should behave if the Fed adjusts interest rates correctly over time.

Bernanke has surprised observers by not pushing hard for the Fed to adopt an inflation target.

The Fed seeks to keep inflation low but does not specify a goal, as do many foreign central banks.

Bernanke had advocated the practice, known as "inflation targeting," during his years in academia and as a Fed Board member from 2002 to 2005 -- prompting expectations he would impose it as chairman.

But Bernanke took a gentler approach, asking his colleagues last year to consider inflation targeting among many options for improving communication with the public.

After several months of discussion, it appears unlikely that they will adopt a formal target, such as 2 percent, but might agree to a softer goal -- perhaps a target range of, say, 1 to 2 percent. No decision is expected soon.

The decision to pause in August also resulted from a vigorous, collegial debate among the top policymakers at their meeting, as has become characteristic of the Bernanke Fed.

The Fed meetings are "more energized, more interactive, more spontaneous" than they were under Greenspan, said Laurence H. Meyer, a former Fed board member.

This reflects Bernanke's general effort to lead in a more low-key way than Greenspan, who had come to dominate and personify the Fed, as did his predecessor, Paul A. Volcker. Bernanke's aim is to strengthen the institution so it will succeed regardless of whether it has a great chairman.

The markets initially were nervous about whether Greenspan was up to the job when he succeeded Volcker in August 1987. But Greenspan quickly established his authority by calming the markets during the October 1987 stock crash, Meltzer said.

It is too soon to know how Bernanke's leadership style will work in a crisis or when there is disagreement within the Fed over policy, Meltzer said. "Let's see what happens if there is real conflict."

But, he added, "I think he's done a good job so far."