Bernanke Favored Rate Cuts Tied to Bubble

By Neil Irwin
Washington Post Staff Writer
Thursday, May 7, 2009

Ben S. Bernanke was a strong internal advocate of the Federal Reserve's decision to cut interest rates to very low levels in 2003, steps that some analysts argue stoked the housing and credit bubbles that are now unfurling with disastrous consequences.

Bernanke was a Fed governor then, and his comments during key meetings -- transcripts of which were released yesterday -- foreshadow the decisions he would eventually make as Fed chairman. He consistently pushed for the central bank to disclose more about its goals for inflation and to communicate more clearly to the public, hallmarks of his three years as chairman.

The Fed releases transcripts of the Federal Open Market Committee meetings after a delay of more than five years.

In 2003, the Fed cut the short-term interest rate it controls to 1 percent and then left it there until 2004. The economy was weak at the time, due in part to uncertainty about the Iraq war, and Bernanke and his colleagues feared the nation was at risk of deflation, a dangerous cycle of falling prices.

"I would like to caution against the situation where we are continually waiting for uncertainty to be resolved before taking action," Bernanke said in a March meeting, just before the Iraq war started. "If the economy is still struggling and if there is no significant improvement or evidence of increasing strength by our next meeting, I hope we will at least consider the case for easing policy at that time."

Three months later, the committee did just that. But Bernanke showed openness to going further. "I think it's premature to conclude that we should not consider further rate cuts, if not at this meeting then at some time in the near future depending on how the data play out," he said.

Part of the low-interest rate policy during that period included a statement from the Fed that it would leave rates low "for a considerable period." There was a spirited debate over whether to use that language in the August 2003 meeting, and Bernanke made a vigorous argument to do so.

He expressed openness to cutting rates toward zero, even if doing so meant the Fed would need to find new tools to stimulate the economy. In recent months, under Bernanke's chairmanship, the Fed has done just that, buying mortgage-related securities and long-term government bonds.

Another recurring theme in Bernanke's comments in the meetings was a desire for the Fed to speak more clearly to the public and financial markets about its intentions. As chairman, Bernanke has used more direct language in talking about the economy and Fed policy than his predecessor, Alan Greenspan, did.

"We've seen in the last two meetings that our words have been far more powerful than our policy decision in terms of changing markets," Bernanke said in August.

In contrast to Greenspan, who relished using ambiguous language about his intentions in order to keep his options open, Bernanke explicitly rejected using mixed signals as a tool.

"Ambiguity has its uses but mostly in noncooperative games like poker," the future Fed chairman said. "Monetary policy is a cooperative game. The whole point is to get financial markets on our side and for them to do some of our work for us. In an environment of low inflation and low interest rates, we need to seek ever greater clarity of communication to the markets and to the public."

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