[From the diaries by susanhu.]
President Bush has nominated Ben Bernanke to replace Alan Greenspan as head of the Federal Reserve. Bernanke has a “name” resume – a resume with a lot of well-respected names on it: Harvard, MIT and Princeton. I have started to comb through the information available online about him and will present it over the next few days or weeks so people can become better acquainted with him. Below are excerpts from an interview in 2004.
Rolnick: For several years now, you’ve argued that inflation targeting will improve monetary policymaking by anchoring the public’s inflation expectations and by improving Fed accountability. Some of us would argue that we’re already practicing something like that de facto, with our public commitment to price stability. In what sense is your proposal a substantive change in policy? If we did move to an explicit target, what would be the benefits?
Bernanke: It’s true that the Federal Reserve is already practicing something close to de facto inflation targeting, and I think we’ve seen many benefits from that. 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 or a numerical range for inflation. I believe that that step, though incremental, would have significant marginal benefits relative to current practice.
First and very importantly, such a step would increase the coherence of policy. Currently, the FOMC [Federal Open Market Committee] makes its decisions without an agreed-upon definition of price stability or of the inflation objective, and one wonders how oarsmen pulling in different directions can get the boat to go in a straight line. I think the FOMC’s decision-making process would be improved if members shared a collective view of where we want the inflation rate to be once the economy is on a steady expansion path.
Second, there’s a great deal of evidence now that tightly anchored public expectations of inflation are very beneficial, not only for stabilizing inflation but also in reducing the volatility of output and giving the Federal Reserve more ability in the short run to respond flexibly to shocks that may hit the economy.
Inflation expectations in the United States are better anchored than they used to be but are still too volatile for optimum performance of the economy. Announcing an actual number or range would serve to anchor public expectations of inflation more firmly and avoid the risk of “inflation scares” that might unnecessarily raise nominal bond yields.
Third, from a communications viewpoint, financial markets would be well served by knowing the medium- to long-term inflation objective of the Fed. An explicit inflation objective would help market participants accurately price long-term assets, both by anchoring long-term inflation expectations and by giving the market better information about the likely path of short-term policy as the Fed moves toward its long-term target. And fourth and finally, I think an inflation target does introduce an additional measure of accountability for the Federal Reserve, although I would put that as least important of the things I’ve mentioned.
Greenspan took great pains to make the Fed more transparent, allowing the markets to see inside the inner-workings of the Fed to get a better idea of the overall interest rate direction. This is beneficial because it allows the markets to plan more effectively. If you own a business, and you have a really good idea interest rates are increasing, your ability to plan for debt-financed future expenditures is better.
Personally, I think targeting an inflation window as opposed to an actual number is a good idea. From a macro-level policy perspective, targeting a single number is much harder than a window.
Rolnick: The federal deficit has once again become a major economic concern. By some estimates, the present value of future debt is over $40 trillion. Can you envision constraints on fiscal policy that are similar to the kind of constraints you’re advocating with inflation targeting? And what is the public role of the central bank on this issue? As a central bank, how should we respond to this kind of scenario?
Bernanke: Well, the central bank has the responsibility to be a nonpartisan adviser on general matters of macroeconomic and financial stability. So to the extent that deficits and debt are threatening macroeconomic and financial stability, the central bank is one actor that can provide advice and counsel to the fiscal policymakers.
Ultimately, though, the determination of the fiscal debt and deficits is the responsibility of the president and the Congress. To the extent that rules or caps can be useful in forcing Congress to look at the whole budget, as opposed to each individual component and then adding them all up, I think that’s certainly worth looking at. But again, that’s a decision for the president and Congress to make.
One of the major allegations levels against Greenspan is he was too political. According to this quote, Bernanke would be less political in his role as Fed Chairman. However, this is one where we will have to wait and see.
According to this quote, it also appears that Bernanke sees the Fed as more independent, reacting to Congressional and Presidential policy decisions rather than trying to implement policy. Again, we’ll have to wait and see on this one.
Rolnick: Some claim they can identify a speculative bubble in a variety of markets. The dot-com sector was viewed as an asset bubble, and then some said we have had a speculative bubble in housing. How confident can we be in identifying such bubbles, and if we can be confident, what’s the role of the central bank in dealing with these events?
Bernanke: I think it’s extraordinarily difficult for the central bank to know in advance or even after the fact whether or not there’s been a bubble in an asset price. The mere fact that an asset price has gone up and come back down again doesn’t mean that there was a bubble in the technical sense that the price movement was completely divorced from fundamentals. Moreover, if a bubble does exist, there is no guarantee that an attempt to “pop” it won’t lead to violent and undesired adjustments in both markets and the economy. The central bank should focus the use of its single macroeconomic instrument, the short-term interest rate, on price and output stability. 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, thereby implicitly imposing its view of the proper level of asset prices on financial markets. 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.
I do think there are several useful things that central banks can do about potential mispricing in asset markets. First, I think that many distortions in asset prices have arisen historically because of various kinds of structural regulatory problems in the underlying markets. For example, research on historical episodes suggests that large asset price increases are sometimes preceded by credit booms. In many cases, this pattern results from the fact that the country in question deregulated its banking system, giving banks extra powers, but did not enhance the supervisory structure adequately at the same time. The result is that institutions have an incentive to make economically bad investments, to take advantage of the “put” provided by the government safety net.
In the wonkish world of Central Bankers, a debate currently rages about a central banks role in asset markets. There are strong arguments on both sides. On the pro-intervention side is the argument the central bank has the opportunity to provide more economic stability by loosely targeting asset prices by cutting off credit when prices seem to lack a fundamental basis. The central question on the con side is: “How can a central bank decide what an appropriate price level is?” Bernanke clearly comes down on the non-intervention side. However, his statement also implies he may be more aware and/or sensitive to the idea of a credit bubble existing, which is clearly within a central banks powers to impact. Although his statements imply he would not directly react to the current housing bubble, he may react to the current over-extension of the US consumer.
