By Robert J. Samuelson
Friday, January 29, 2010; A21
Now that the Senate has confirmed him for a second term as chairman of the Federal Reserve, Ben Bernanke has, or ought to have, a very simple agenda: improve confidence. This isn't his job alone, of course. President Obama and Treasury Secretary Timothy Geithner are hardly bit players. But what Bernanke does and says -- how he projects himself and the Fed -- matters a great deal, and he faces an exacting challenge.
There is a supposition among academic economists (the tribe from which Bernanke comes) that "economic policy" consists of making decisions about interest rates, taxes, government spending and regulations that translate, almost mechanically, into actions by firms and consumers to hire or fire, spend or save, invest or hoard. By now, Bernanke surely recognizes that this economic model is at best a half-truth.
The famous British economist John Maynard Keynes (1883-1946) coined the phrase "animal spirits." Less elegantly, we say "emotions." Whatever the vocabulary, the lesson is the same: Psychology matters. Booms proceed from overconfidence; busts inspire great fear. Recoveries require increasing optimism. Otherwise, despondent consumers confine buying to necessities, and businesses delay hiring and expansion.
By many measures, confidence has already improved. At the depth of the crisis in October 2008, 73 percent of Americans rated the economy "poor" and 84 percent thought it was "getting worse," according to Gallup surveys; recent responses in mid-January were 47 percent and 58 percent -- dismal but better. Interest rates on many bonds have dropped sharply. In October 2008, high-quality corporate bonds fetched 9.5 percent; now, that's about 6.2 percent. Lenders have become less risk-averse; credit markets, though damaged, are working better.
Still, confidence remains fragile, for obvious reasons. Unemployment is 10 percent and may stay high for years. The Congressional Budget Office's latest outlook has it averaging 10.1 percent this year, 9.5 percent in 2011 and 8 percent in 2012. Against that backdrop, Bernanke's confidence-building mission faces two problems.
One is that much of Washington is conspiring to corrode confidence. Given the importance of psychology, how could that be? Simple.
A crisis usually inspires either political unity ("we're all in this together") or gamesmanship ("blame them, not me"). This crisis has produced more of the second than the first. Of course, fact-finding and corrective actions are inevitable and desirable. But much of what's happening today is old-fashioned political grandstanding. To be sure, Bernanke didn't foresee the crisis, but his aggressive response contained the damage. Casting him and the Fed as handmaidens of Wall Street gives vent to populist anger but doesn't explain what happened. Unwise proposals to restrict the Fed's powers -- to limit its power to regulate large financial institutions and subject it to ongoing "audits" -- have made headway.
There are dangers. One pillar of confidence is the belief that the Fed can act quickly and decisively in a crisis; arguably, that's what spared us a deeper downturn. But now Congress may curb those powers or so vilify the Fed that it becomes intimidated. Compounding this uncertainty are unsettled policy questions involving health care and financial "reform." The administration's decision to push health-care legislation was a blunder. It sowed conflict and was so time-consuming that it paralyzed action on other issues. Business planning and the willingness to expand have suffered, because companies find it harder to predict their costs and returns.
The second problem, though technical, is also crucial. During the crisis, the Fed became the "lender of last resort" for much of the economy. It created special lending facilities to support banks, money market funds and the commercial paper market. Fed lending grew by more than $1 trillion. These facilities stopped the financial panic, and private credit flows resumed. The Fed is closing most facilities Feb. 1. But as this lending subsided, the Fed expanded lending elsewhere. Specifically, it committed to buy $1.75 trillion of Treasury securities and mortgage-related securities. The goal was to reduce long-term interest rates. By some studies, rates may have dropped one percentage point on some mortgages and half a point on 10-year Treasury bonds.
The question is when and how to end this policy of easy credit, which is augmented by an effective interest rate of zero on overnight Fed funds. Purchases of Treasury bonds have already ceased; buying of mortgage-related securities is now scheduled to stop in March. The Fed faces a classic dilemma. If it retreats too rapidly from easy credit, higher interest rates could sabotage the recovery. But maintaining easy credit policies too long could backfire if they raise inflationary expectations and trigger a loss of confidence in the dollar.
Bernanke will no doubt savor his confirmation, but whether he inspires confidence depends on his responses to enormous political and economic problems, both known and unknown.