Jewish World Review Oct 28, 2005 / 25 Tishrei, 5766

Faceless face at the Fed

By Robert Robb

http://www.JewishWorldReview.com | One of the most important tasks for new Fed Chairman Ben Bernanke, assuming what should be an easy confirmation, will be to make his job less important.

Bernanke seems well suited to do that, which is a compliment. The primary economic contribution that a central bank can make is to maintain a stable currency. Bernanke's predecessor, Alan Greenspan, has certainly led the Federal Reserve Board in accomplishing that during his 18-year tenure.

But Greenspan also clearly saw a role for the central bank in fine-tuning and regulating the overall economy, pressing the gas when the economy was slowing, putting on the brakes when it was growing faster than Greenspan thought prudent. Over the last six years, the Fed has changed the interest rates it sets some 30 times.

Greenspan was also a high-profile kibitzer about fiscal policy and other issues, such as Social Security reform. His public standing was so high that both parties sought to use his often opaque pronouncements to advance their positions.

Republicans stressed that Greenspan supported tax cuts and thought they should be made permanent. Democrats stressed that he worried about deficits and thought tax cuts should be offset. Neither party made much of Greenspan's view that offsets should occur primarily if not exclusively through reductions in federal spending, since neither party has the stomach for doing it.

This broader role of the Fed chairman as an economic oracle and, in Bob Woodward's highly unfortunate metaphor about Greenspan, maestro is unwarranted and potentially dangerous.

The Fed can ruin the economy by creating inflation or depriving it of liquidity in a downturn. But the tools available to the Fed are insufficiently powerful or precise to be constantly fine-tuning economic performance.

In reality, the interest rates the Fed sets only affect the cost of capital at the margins. Long-term interest rates have remained remarkably impervious to the Fed's six-year period of hyperactively seeking to influence them. That's in part because the Fed has done its primary job of maintaining price stability so well, since long-term interest rates are in significant part a function of inflation expectations.

The Fed has more direct influence on the money supply and thus inflation. But even here, there's a great deal of imprecision. It's hard to control what is increasingly more difficult to define and measure.

Because of his public standing, Greenspan was able to get away with drifting into fiscal policy and other issues. But it's a dangerous undertaking for a central banker. Getting into the business of politicians in other areas increases the risk of politicians trying to get into monetary policy. And that, history proves, is a pathway to economic disaster.

When President Bush appointed him, Bernanke was careful to say that he sought "continuity" with Greenspan's policies and strategies. But there is reason to believe that he will depart from Greenspan's approach in ways that are useful and beneficial.

Bernanke is one of the foremost advocates of a central bank publicly setting an inflation target. Greenspan resisted this because it would limit flexibility. But that's actually one of its virtues.

A publicly set inflation target obviously puts price stability above other economic goals, decreasing the temptation to attempt to fine-tune the economy. Moreover, it more properly aligns public expectations with what a central bank can and should do, which is to maintain a stable currency.

As Bernanke put it in a Wall Street Journal column he co-wrote in 2000: "(T)he transparency of the inflation-targeting approach would encourage politicians and the public to focus on what monetary policy can do (namely, maintain long-run price stability), rather than on what it can't do (create permanent increases in growth through expansionary policies)."

Bernanke has a calm view of the so-called twin deficits, the current account deficit in trade and investment and the federal budget deficit. He brought fresh insight into the current account deficit by arguing that it was more a function of a worldwide savings glut finding safe harbor in the United States than a reflection of fundamental flaws in the U.S. economy.

He's also more likely to stick to his knitting publicly than Greenspan was, leaving fiscal policy and other issues to the politicians elected to tend to them.

Achieving a stable currency is a remarkable and powerful economic achievement. But done right, the doing of it should be practically unnoticed.

If, in five years, Bernanke is as well known as Greenspan is today, it will be more a sign of failure than of success.