October 28, 2005 

Ben Bernanke.  Earlier this week President Bush nominated current Chairman of the Council of Economic Advisors Ben Bernanke to replace Alan Greenspan as Chairman of the Federal Reserve.  Greenspan’s term as a Governor of the Fed ends at the end of January and he has announced that he plans to step down as Chairman at that time.

Bernanke is an interesting choice.  He is a very well respected academic economist, author of two very popular textbooks, and has a fine reputation in economics community.  Before becoming CEA Chair Bernanke was a Governor at the Fed from 2002 to 2005.  Before heading to the Fed he was head of the econ dept and chair holder at the Woodrow Wilson School at Princeton.  He has an undergrad degree from Harvard and a PhD in economics from MIT.

So Bernanke hasn’t spent a lot of time in Washington nor has he had much contact with the Bush Administration.  Unlike some of the other “leading contenders” to replace Greenspan, Bernanke has never worked for another Republican administration (as did Martin Feldstein) or help Bush in his campaign (as did Glenn Hubbard).  So Bernanke can’t be considered much of a partisan.  This is unlike Greenspan who had a long history of working for Republicans before he was picked to be Fed chair.  The financial markets feared (wrongly) that Greenspan would be a monetary lapdog for Republicans, ala Arthur Burns for Nixon.  This time around the financial market shot up when Bernanke was nominated…this stock market rise has been labeled the “Bernanke Bounce.”

So…what can we expect out of Bernanke headed Federal Reserve?  One thing is for sure:  he will be much easier to understand than Greenspan.  Often when Greenspan speaks you feel like you need a roomful of translators to figure out what he just said.  One can spend hours pouring over one of Greenspan speeches and still not have a clue as to what he was trying to say.  Bernanke on the other hand writes and speaks in clear everyday English.  You can see this in his textbooks as well as his speeches.  He is clear and relatively concise.

So what does Bernanke have to say?  He has put forward the idea that there is a “Global Savings Glut” in explaining the current account deficit in the U.S.  He points out that while Asian households save a lot, Asian and European firms invest too little, and Americans save far too little the current account deficit can be traced back to this saving glut.  The savings pour into savings-less America from the savings abundant (and business investment shortage) rest of the world.  So…don’t look for Bernanke to call for intervention in the foreign exchange market any time soon to “correct” the current account deficit. 

In addition, Bernanke has been a major proponent of inflation targeting.  Under this type of monetary policy the central bank states publicly that the purpose of monetary policy is keep in the inflation rate below a certain level.  This is the approach taken by the European Central Bank, while the Fed has traditionally operated with multiple, if vague, policy objectives.  The will probably, slowly move more toward a formal inflation targeting regime.

Also, Bernanke has been a big supporter of a monetary policy reaction function.  These functions usually follow some type of Taylor Rule for monetary policy.  That is, changes in monetary policy are in reaction to changes in the gap between actual and expected output, the real interest rate, actual inflation, expected future inflation and the bond rate.  Watch for a lot of discussion over what is the exact form of a reactionary function a Bernanke Fed is following.

Bernanke has also been critical of central banks that attempt to target asset prices.  That is, Bernanke believes the Fed should not concern itself over asset bubbles in real estate or equities until these asset prices threaten to spillover into consumer prices.  Thus, watch for a Bernanke Fed to worry less about the potential for a real estate asset as opposed to Greenspan’s recent warnings of the growing household asset bubble.

Finally, some wonder how tough of an inflation fighter will Bernanke actually be? Bernanke certainly seemed to be worried about deflation in 2002.  He argued for a rapid increase in the money supply to fight of potential deflation quipping we could throw money from a helicopter if need be to increase the money supply.  This is actually a very old mental picture painted by monetary economists…I remember my old money & banking professor, Donald Hester at Wisconsin, using this helicopter example back in the early 1980’s.  The point Hester and Bernanke were trying to make is that there are various ways to increase the money supply other than just lowering the target for the Fed Funds Rate.  So I was a bit surprised when the financial press was “shocked” by this example and thus labeled Bernanke as “Helicopter Ben.”  The point to take away from this is watch for a Bernanke Fed to use more tools than the traditional Fed Funds target and Discount Rate.

So to me, the fears that Bernanke will be soft on fighting inflation are probably exaggerated.  Changes that will come in monetary policy will probably be slow in coming.  But for the most part, greater transparency, rules based decision making, greater discussion of the U.S. lack of savings, etc. will all be positive things.

All the best,

MBrandl