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Bernanke—the Rebel with a Cause

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics
December 19, 2012
Financial Times


To understand Ben Bernanke, it helps to set aside the ubiquitous pictures of today's 59-year-old: the controlled beard, the pristine shirts, the worn-down weary look. Instead, search for a snap of the freshly minted graduate who gazes from the pages of the 1975 Harvard yearbook. Unlike the other young men pictured alongside him, Mr Bernanke sports no tie and no blazer. He has a loud checked shirt, long hair and a tremendous, rebellious handlebar moustache.

The moustache may be gone, but the US Federal Reserve chairman remains a rebel – and the world is better off for it. The Financial Times has already crowned its man of the year: Mario Draghi, the European Central Bank president. But my pick for silver medal is Mr Bernanke. The fact that he is sometimes pilloried only underlines his fortitude.

Mr Bernanke's first gamble as Fed chairman was to inject $1.5tn into frozen financial markets in late 2008. In comfortable hindsight, this lender of last resort activism looks like a no-brainer: the Fed averted a 1930s-style depression and made a profit to boot. But at the time, Mr Bernanke's actions provoked consternation. He secured his second four-year term in a Senate vote that was split 70 to 30, the lowest margin for any Fed chief since the central bank's creation.

Mr Bernanke's second gamble was to drive the Fed's policy rate in effect below zero by buying long-term securities. Again, this prompted uproar: wouldn't the Fed's "quantitative easing" result in inflation? Newt Gingrich, the erstwhile Republican presidential hopeful, called Mr Bernanke "the most dangerous, inflationary" Fed chairman in history. Rick Perry, the governor of Texas, went even further: "If this guy prints more money between now and the election, I dunno what y'all would do to him in Iowa, but we would treat him pretty ugly down in Texas." However, Mr Bernanke has been vindicated. The Fed's measure of core inflation has plodded along quietly at less than 2 per cent.

Now Mr Bernanke has launched his third gamble. In laying out the next phase of the Fed's bond-buying plans, he has shifted from the familiar commitment to buy a specified amount over a specified period. Instead, he has emphasised that the Fed will buy however many bonds may be needed to achieve its objectives. There is no limit to the quantity and no limit to the duration. Quantitative easing is quantitative no more.

This revolution recalls the 1990s, when the earlier fixation on the money supply was replaced (tacitly in the US, explicitly in other advanced economies) by a target for inflation. Then and now, the focus on a proxy for inflationary pressure – the quantity of money circulating in the economy, or the quantity of bonds on the central bank's balance sheet – gives way to a focus on the outcome that policy makers actually care about, which is non-inflationary growth.

This switch is commonsensical. Why target a proxy when you can target the real thing? But its true genius is that it builds an automatic stabiliser into the economy. If the Fed specifies how many bonds it will buy monthly, a sudden slowdown will not change what people expect from monetary policy; investors and consumers will react to slower growth by cutting spending, creating a snowball effect. But if the Fed pledges to do whatever it takes to keep the economy advancing, a slowdown will cause people to expect offsetting Fed action. Interest rates will fall in anticipation of easing. With luck, the snowball melts.

But that is just half of Mr Bernanke's recent shift. In moving the focus from the size of the Fed's balance sheet to its objectives for the economy, he has explained that these objectives include lower unemployment even if that means temporarily higher inflation. This is genuinely radical: for more than three decades, the Fed's leaders have avoided any such statement. Over the long term, central banks alone determine the level of inflation, whereas long-run employment is determined by the flexibility of the labour market and other structural factors. Central bankers have seen no advantage in claiming responsibility for something they could affect only partially, especially since they needed to build credibility as foes of inflation.

In his academic career, Mr Bernanke contributed to the consensus in favour of targeting inflation. He always said that the target should be pursued flexibly, meaning that temporary deviations might be acceptable. Yet now he has seized that footnote and made it the headline. In declaring himself open to a temporary price spike, he is betting that long-term inflation expectations are well anchored, so that wage claims remain moderate and no inflationary spiral sets in. Janet Yellen, the Fed's vice-chair, has explored how much looser Fed policy should be under these assumptions. The answer is: a lot.

There are risks here, clearly. The Fed is gambling on expectations about prices, which may prove fickle. It is hoping that massively stimulatory policies in the short run will not be mistaken for a loss of inflation-fighting resolve over the long run. But the Fed confronts an economy in which 5m Americans have been jobless for six months or more. The risks of inaction outweigh the risks of action. Mr Bernanke has rebelled against a monetary consensus to which he himself contributed. But he is a rebel with a cause.

The writer is a senior fellow at the Council on Foreign Relations and an FT contributing editor

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