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Rethinking Bernanke, and the Fed's Power

Jerry Webman

I recently found out that Federal Reserve Chairman Ben Bernanke will be speaking at my youngest child's college graduation ceremony. If I can get over the relief of having written my last college tuition check--there were four sets--I'll be listening especially closely for a hint of how monetary policy may evolve and how investors should prepare. Of course, I won't get any. Instead, I expect to hear the exhortation to public service that befits a senior government official but doesn't reveal anything that the latest "Fed speak" hasn't already covered, however obliquely, about the course of the central bank's actions. If, however, Professor Bernanke decides to use the occasion to reflect on what the Fed has done and what it might need both to do and to say it's doing, I have a few suggestions.

First I'd like to hear the Chairman's thoughts about the implications of the vastly enlarged role the central bank now plays in the economy. In the wake of the 2008 serial collapses and threatened collapses of marquee global financial institutions, the Federal Reserve went to the very edge of (and maybe beyond) its legal authority and became the financial system's lender or purchaser of last resort. In its size, if not entirely in its substance, the Fed's large-scale asset purchase program (better known as quantitative easing) was a bold and unprecedented policy move.

Is now the time right to rethink whether the more routine regulatory and money-supply responsibilities of the central bank ought to be separated from the kind of emergency powers the Fed seized in late 2008 and early 2009 when Congress, facing a stock market meltdown, passed TARP? More broadly, does such a crisis require an "undemocratic" institution like the Fed to act when political gridlock blocks Congress and the executive? If so, with what level of accountability?

A second question is what happens if things go too well? Recent economic reports have been consistently surprising on the upside, and markets are generating much better returns than most observers would have forecast a few months ago. Those two sets of positives tend to reinforce each other: a sounder economy builds confidence in the stock market and increasing wealth motivates both businesses and households to spend and invest. While we're far from overheating, we are also far from the monetary policy conditions that underlay past economic expansions.

For most of the post-World War II era, the Fed has relied on one or two policy instruments--setting short-term interest rates or changing bank reserve requirements--to pursue its dual mandate to promote economic growth and keep prices stable. It didn't always do the best job employing even those relatively simple tools, and when it erred most egregiously, as during the 1970s or the mid-decade 2000s, its mistake was to leave monetary conditions too easy for too long. It failed, in the famous phrase of its longest-serving chairman, to take away the punchbowl before the party got too raucous. But now the Fed has a shed full of policy tools to use: setting interbank interest rates, adjusting interest the Fed pays banks to keep extra reserves in the Federal Reserve system, deciding when to sell a vault full of securities, using arcane money-absorbing devices such as reverse-repo instruments, and probably a few more that we haven't yet heard about.

It's not the tools, though, but the willingness to use them as well as the continued political support necessary to keep them employed that will be the difference between what 1970s Fed Chairman Arthur Burns called "The Anguish of Central Banking" and his successor's successor Paul Volker's legacy of slaying the inflation dragon. Can Chairman Bernanke describe how he and his colleagues will sort out all those complicated tools and figure out which ones to use and when? How will he maintain the support of Congress and the administration when the bank's decisions have painful consequences?

Granted, if he really gives this sort of address, I may be one of the few proud parents who'll still be awake when he finishes. Maybe he really ought to talk about public service. At a time when a mere 19 percent of the public reports trusting government most or all of the time, we might learn something from someone who's spent the past decade away from the groves of academia and in the turmoil of Washington politics, enduring all the abuse Congress and the media can inflict (though my own experience suggests that faculty politics might have made Congressional hearings seem tranquil). I doubt it's the $200,000 salary he's been paid or even the speaker fees that he'll command after leaving the Fed. So why do it?

However large or small you think government ought to be, we all want capable, honest individuals to accept its assignments. In today's environment of gridlock, recrimination, and blame, what will motivate these new graduates to devote some portion of their careers to proving the critics wrong? Answering that question meaningfully might even be more important than clarifying the relative efficacy of reverse-repo and interest paid on excess reserves in managing the money supply.

Jerry Webman is the author of MoneyShift: How to Prosper from What You Can't Control and Chief Economist at OppenheimerFunds.

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