A reserved man
The new nominee for the chairmanship of the Federal Reserve has a background in academia rather than finance and is thought to be weak on inflation. Markets are being urged to wait before rushing to judgement.
Can you ever replace a god? On 24 October George W Bush made an attempt, nominating the head of his Council of Economic Advisors, Ben Bernanke, as the next chairman of the Federal Reserve.
Replacing the supreme being who led the Fed for 18 years, however, a man whose towering reputation far overshadowed the institution he led, will not be easy, especially as America enters a time of economic uncertainty. Greenspan is associated with unprecedented economic prosperity by the markets and civilians alike. Only two mild recessions marred his tenure, and the 10-year expansion that preceded the 1990-1991 downturn was the longest on record. Bernanke is “going to have to earn his spurs”, said Neal Soss, the head of American economics at CSFB in New York.
Yet Greenspan “didn’t start by being a semi deity”, points out Soss. On 2 June 1987 President Ronald Reagan announced Greenspan’s appointment and the Treasury market suffered its worst one-day fall in five years, with the 30-year bond slumping more than three points. Greenspan’s predecessor Paul Volcker left big shoes to fill, literally: Volcker stands 6ft 8in. “Volcker is sort of a financial demigod, and it’s hard for anybody who’s new to develop that stature,” said Robert Hormats, then and now a vice president of Goldman Sachs, on the day of Greenspan’s appointment.
By comparison, Bernanke’s appointment was warmly welcomed by the financial markets. The Dow Jones Industrial Average jumped nearly 170 points on the news. Bond prices fell slightly, but the yield on the 10-year ticked up just six basis points.
In part, the markets were relieved that Bush opted for a known quantity — Bernanke spent two years on the Federal Reserve Board before moving to the CEA last year — and not a Texas crony. But economists were unanimous in praising Bernanke’s qualifications. He is “absolutely” a good choice, said Soss, who once served as Volcker’s assistant at the Fed. “In an academic sense and in a policy sense, Bernanke has been preparing for this his entire career.” Not even opposition Democrats on an increasingly polarised Capitol Hill could find fault. “Dr Bernanke brings academic distinction to this position. In addition, he has substantial government experience,” said a statement issued by Paul
Sarbanes, the ranking Democrat on the Senate Banking Committee.
Senate confirmation is all but certain. Hearings are likely to begin in the next two weeks, meaning Bernanke could be confirmed in the job by the end of November, just before his 52nd birthday. Greenspan’s term expires at the end of January, six weeks before the great man’s 80th birthday.
Where Greenspan brought an intricate knowledge of the financial markets to Washington — he ran a forecasting firm in New York before moving to the Fed — his successor Ben Shalom Bernanke’s background is in academia. Joining the economics faculty at America’s elite Princeton University in 1985, Bernanke was always a bit of a swot. Born in Augusta, Georgia on 13 December 1953, he grew up in tiny Dillon, South Carolina where he was the state spelling bee champion at age 11, although he was knocked out of the national competition for failing to correctly spell “edelweiss”. He earned a bachelor’s degree in economics from Harvard, graduating summa cum laude in 1975, and a doctorate in 1979 from the Massachusetts Institute of Technology.
California’s Stanford University, where he developed an interest in the role of the Federal Reserve during the Great Depression. There are fears that his extensive research of that era may have created a closet dove. Worries that Bernanke may not be as tough on inflation as his predecessor explains the increase in bond yields on the day of his appointment. Bernanke has done little to disabuse the markets of that notion. “Overall inflation is likely to return to levels consistent with price stability in coming quarters,” he told the Joint Economic Committee of Congress less than two weeks ago. “He’s a little bit associated with a soft money point of view. He’s going to have to demonstrate (his inflation-fighting credentials) right away,” said Soss.
Bernanke might dispel those fears by introducing an inflation target, an idea he has advocated for years, opposing the views of Greenspan. In an interview published last year, Bernanke admitted that “the Fed is already practising something close to de facto inflation targeting. My main suggestion is to take the natural next step and to give an explicit objective, that is, to provide the public with a working definition of price stability in the form of a number of numerical range for inflation.”
Bernanke will take his time before introducing any major changes to the way the Fed works, say economists, but few rule out an explicit target over the medium term, along the lines of 1 to 2 per cent annual growth in personal consumption expenditure.
Publishing an inflation target would go some way toward achieving Bernanke’s other goal: increasing the transparency of the Fed’s operations. Greenspan elevated obfuscation to an art form, once telling Congress, “If I seem unduly clear to you, you must have misunderstood what I said.” During the early years of Greenspan’s reign, the Fed didn’t even announce changes to its overnight rate.
However, the Fed has become more open of late. Interest rate changes are formally revealed and, earlier this year, the Fed published its first twoyear inflation target. That’s a change specifically advocated by the incoming Fed chairman. In that 2004 interview, he “suggested that the FOMC (the Fed’s interest rate setting committee) release more information about our view of the state of the economy, with the purpose of trying to help the public and the markets better understand what our perspective is and what policy is likely to be doing in the future.” Of course, there can be too much transparency. “Televising the FOMC meeting would not be productive.
Economists welcome the prospect of greater transparency, but warn of increased turbulence in the markets. “This could provoke market volatility since communicating nuanced views could lead to more ‘Fedspeak’ trades,” said Soss. But there is one point on which Greenspan and his likely successor are in complete agreement: central banks should not attempt to prick asset price bubbles. “It is rarely, if ever, advisable for the central bank to use its interest rate instrument to try to target or control asset price movements. History has shown us clearly that that type of policy has more often than not led not only to a large decline in asset prices but also to a large decline in the general economy,” said Bernanke in that interview
He should hope those words don’t come back to haunt him. Aside from rising inflation, courtesy of sky-high oil prices, America could also be facing a house price bubble. Existing home sales fell in the month to September — after a blistering acceleration in August — but still rose by more than 13 per cent year on year. A deflating house price bubble could be Bernanke’s first challenge. If he passes that test, he too, could be on the way to deification. Just two months after Greenspan took over as chairman of the Fed in 1987, the stock market suffered its biggest ever one-day fall, losing 20 per cent of its value on 19 October. Greenspan’s deft handling of that crisis laid the foundations for what many believe to be one of the most successful reigns as Federal Reserve chairman.