If Ben Bernanke had known what was coming when he was offered the chairmanship of the Federal Reserve in 2005, he might have turned the job down. Most sane men would, and Bernanke is as sane as they come. The United States was lucky he was there when having an outstanding Fed chairman mattered so much. This was his last week in charge: He’s mostly being applauded, by economists at least, and he richly deserves it.
Bernanke is an academic authority on the Great Depression. This was enormously valuable, even though (as he emphasized in a recent speech on the Fed and the crash) financial markets have changed out of recognition since the 1930s. One timeless lesson of the earlier crisis is that when the Fed is faced with a financial emergency, it has to be bold: Dithering and half-measures can be fatal. Within the constraints he faced — a point I’ll come back to — Bernanke applied that wisdom, and re-purposed it for modern conditions.
When the crisis hit, panic drained liquidity not just from commercial banks and other deposit-takers but from an array of new "shadow banking" intermediaries. To be an effective lender of last resort, the Fed had to operate much more broadly than the orthodox view implied. It did. Later, with the crisis contained, the Fed led "stress tests" of the banking system to see which parts were solvent and which weren’t. This was novel too. Compare the Fed-managed exercise for rigor and disclosure with the European equivalent. The first helped to restore confidence; the second, rightly seen as a sham, prolonged the crisis.
Bernanke’s Fed was bold and innovative in macroeconomic policy as well. With short-term interest rates cut to zero, its main policy instrument became ineffective. So the Fed bought enormous quantities of assets to drive down long-term interest rates. Quantitative easing worked, and it was vital. The Fed found a way to deliver additional monetary easing at a time when Washington was withdrawing fiscal stimulus. In supporting demand, Bernanke wasn’t just acting alone, he had to contend with a broken budget system that was actually making the recession worse.
QE has been controversial partly because it’s new. Anything new, adopted on this scale, involves uncertainty. The question is whether the benefit justified the risk. We won’t know for sure until QE is unwound — but on the evidence at hand it was the right policy. A feeble recovery from a ferocious recession would surely have been even weaker if not for QE.
The idea that the asset purchases should have been both bigger and sustained for longer — rather than being scaled back, as they were again at Bernanke’s last policy meeting last Wednesday — makes a lot more sense than saying the Fed went too far. The Fed has the tools to tighten later when it needs to; for now, inflation is lower than target and the labour market is slack. But give the man credit: Bernanke resorted to QE on a scale that would have been hard to envisage before the crash.
Pressed too far, demands for the Fed to be even bolder are naive. Economists are mostly impressed with Bernanke’s record, but conservative politicians and pundits certainly aren’t. That’s a problem, because to remain an effective central bank the Fed needs to guard its operational independence, and its freedom to act isn’t guaranteed. Up to a point, Fed chairmen can evade or push back against critics in Congress — Bernanke did, and so did Paul Volcker in the 1980s — but the Fed can’t act as though Congress wasn’t there.
This puts limits on how radical it can be. For instance, some argue that the Fed needs an entirely new approach to monetary policy. Instead of a target for inflation it should adopt a target for the price level several years ahead, or for the level of nominal gross domestic product; or maybe it should raise the inflation target to four per cent or more.
The economic reasoning behind such proposals is appealing. What they have in common is the idea that expectations of higher inflation would lower real interest rates even when nominal rates are at their zero floor — which is true, of course. But if QE arouses fierce opposition, what would be the reaction in Congress to the Fed’s announcing an actual intention to cause higher-than-target inflation?
There are strictly economic objections to this family of ideas as well, starting with the idea that the Fed’s credible commitment to low inflation was hard to establish, has many benefits, and should not be discarded — but put the economics to one side. Politics constrains the Fed, and a chairman who chose to ignore that fact would put the institution, and its ability to do its job, at risk.
I haven’t agreed with Bernanke about everything. I think his fondness for detailed "forward guidance" — meant to convince investors that short-term rates will stay low for longer — is unwise, and apt to cause more confusion than it dispels. The tapering of QE could have waited a while longer. I also think the Fed has made too little progress on so-called macro-prudential regulation. This is the main item of unfinished business post-crash. Again, though, the Fed can’t go it alone on regulation: It has to work with legislators and other regulators, both at home and abroad.
History will render the final verdict, but I’ll be astonished if Bernanke doesn’t go down as a great Fed chairman — the right man in the right place at the right time.
Clive Crook is a member of Bloomberg View’s editorial board.
— Bloomberg News