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Analysis

A Tougher Tone at the Top

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By Neil Irwin
Washington Post Staff Writer
Saturday, January 19, 2008

When Ben S. Bernanke became Federal Reserve chairman two years ago, he set out to be the man in the gray flannel suit -- more anonymous bureaucrat than swashbuckling master of the economy.

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Now Bernanke is discovering that, in times of crisis, the world wants a swashbuckler.

After months of criticism from people on Wall Street who argue that Bernanke has responded timidly to the crisis in the housing and credit markets, he has taken a more assertive approach. Last week, he gave a speech that used bold language to signal that the Fed would cut interest rates to try to prevent a severe economic downturn. On Thursday, he told Congress how to design a stimulus package that would offer immediate help.

The two moves are meant to assure financial markets, elected officials and the American public that the Fed is on the case.

"The financial markets and the whole society are crying out for leadership," said Alan S. Blinder, a Princeton economist and former Fed vice chairman. "Bernanke as a person and the Fed as an institution are the places this leadership can come from."

It is all but inevitable, in the view of Fed leaders, that the economy will grow slowly in the first half of 2008. There may even be a mild recession, they say. But Bernanke is trying to indicate that he and his colleagues at the central bank will not let a painful, self-reinforcing cycle set in that could cause a severe and prolonged downturn.

In this highly negative scenario, lower home prices cause foreclosures, which cause more losses in the financial sector, resulting in less credit available to consumers and businesses, leading to still lower home prices.

"By cutting interest rates to offset the negative effects of financial turmoil on aggregate economic activity, monetary policy can reduce the likelihood that a financial disruption might set off an adverse feedback loop," Frederic S. Mishkin, a Fed governor, said in a recent speech. Mishkin's thinking is generally close to that of Bernanke.

The Fed is taking a page from the playbook of Alan Greenspan, Bernanke's predecessor. By cutting interest rates aggressively at the end of January and beyond, as is likely, the Fed would be an example of "risk-management" strategy -- trying to prevent a situation that, however unlikely, would be disastrous.

Part of that negative cycle the Fed fears is psychological: Fear of rapidly dropping home prices and further financial crisis makes it more likely to happen. That's where the tough talk from Bernanke comes in.

One of the idiosyncrasies of being a central banker is that words can matter as much as policy. If, because of his recent speeches, people believe a severe recession is less likely, then they will be more willing to spend and invest.

In that sense, Bernanke's recent behavior is at odds with his stated desire to reduce his presence in the spotlight. "Bernanke did want to be more anonymous and behind-the-scenes kind of person," said Dean Croushore, a University of Richmond economist who wrote a textbook with Bernanke. "But in a crisis, that's when people have to step up to the plate, and that's what he's doing."


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