Ben Bernanke' choice as the next Fed Chairman is
a very good one: he is extremely bright, a leading
academic scholar and a first rate expert in
macroeconomics and monetary policy; he has wide
policy experience as Fed governor and now
as Chairman of the White House Council of Economic
Advisors; he has a broad and sophisticated - if
somehow controversial -understanding of
international macroeconomic issues. Also, while
being a Republican, he is not a partisan hack or
too closely associated with the White House and
Republicans; he certaintly passes the test of an
independent mind. He does supports the Bush tax cuts
and other mainstream market oriented economic views
but he is not a supply-side hawk or a market
fundamentalist; his economic views - like those of
Greenspan - are pragmatic and he is open to consider
carefully all the relevant empirical evidence on
economic and policy issues rather than being driven
by rigid ideological blinders in his decision
making. In this sense he is a wise and pragmatic
policy maker.
He does not have direct financial markets
experience and the White House would have preferred,
if they had found one, to choose a "Republican
Rubin" with such a broad experience. But there is no
Republican Rubin - i.e. someone with the caliber,
charisma, market and financial experience, and
policy savvy of Bob Rubin - out there among the
heads of private financial institutions or corporate
CEO; thus, out of the other three leading choices
for the Fed job - Hubbard, Feldstein and Bernanke
- Bernanke is certainly the best one, even if
Feldstein would have also been a very good Fed
Chairman.
On the substance, at the beginning of his
term Bernanke will follow the pragmatic "risk
management" approach favored by Greeenspan. Also,
while he is has been a strong supporter of a formal
"inflation targeting" approach to monetary policy,
he will not initially push for such a significant
change in the monetary policy regime, at least until
his leadership is more strongly established over
time. While he is pragmatic in his approach to
monetary policy, at the beginning he will have to be
an anti-inflation hawk in order establish
his low-inflation or price stability credibility, in
the same way in which the ECB had to be hawkish
after its establishment to build its low-inflation
reputation. The last thing he can do is to afford to
be perceived as an inflation wimp at the time when
inflation expectations and actual inflation are
rising; markets would not forgive such initial
softness on the inflation front. So, he will not
make such a mistake. Moreover, he will have to move
carefully on inflation targeting as any attempt to
formally change the framework of US monetary policy
towards "inflation targeting" may lead Congress to
try to interfere and impose politically damaging
conditions on monetary policy: for example, Congress
may argue that, if we move to a formal inflation
target, we should also have a formal "high GDP
growth" target, a political interference that would
undermine the appropriate conduct and flexibility of
monetary policy. So, I am not sure that inflation
targeting will ever be adopted by the Fed, even
during a Bernanke Chairmanship, as such a move would
be fraught with many congressional interference
obstacles. More likely the Fed - even more than it
is doing now - will make its two-year
ahead inflation forecast - i.e. its implicit
inflation target - even more clear to the public and
the markets as an indirect signaling of an implicit
- but not formally explicit - inflation target.
On monetary policy and asset prices, Bernanke has
the same views as Greenspan, i.e. do not try to
prick a rising asset bubble but try to avoid the
collateral damage of a bursting one with monetary
easing. Thus, he will have to be careful about not
generating an alleged "Bernanke put" after the
alleged "Greenspan put". In fact, given his
expressed beliefs - during the brief period of
US deflation risk in 2002-2003 - that "unorthodox"
policy tools may have to be used to fight deflation,
markets may expect him to come to bail them out if
and when a systemic risk episode - such as a
bursting of the housing bubble - occurs. Thus,
again, he may have to start as a relatively monetary
policy "hawk" to dispel any perception of a
"Bernanke put" and market expectations of monetary
bail-out if the housing bubble bursts.
On global imbalances, his views differ
somehow from those of other Fed officials: he
believes that the US current account deficit is
caused by a "global savings glut"; while Tim
Geithner, president of the New York Fed - as well as
some other Fed governors - are much more concerned
about the US current account deficit sustainability
and about the domestic causes - the budget deficit
and the private sector savings drought - of this
external imbalance. So, to dispel the impression
that he is justifying and supporting the fiscal and
deficit policies of the Bush administration, he may
have to start worrying about the fiscal deficits and
the current account deficit more than he has in the
past.
So, this is a very good choice as he is someone
very smart, ideologically pragmatic, with
intellectual and academic rigor but also policy
savvy and experienced. The true test for him will
come early next year when a U.S. economic slowdown
with rising headline, core and expected inflation
will lead to a serious policy dilemma for the Fed:
to continue tightening to control inflation
expectations or to take a pause. He will have to
keep on tightening well above 4.25% and towards 5%
if the rise in headline and expected inflation feeds
into the core inflation measures; and he will have
to do that even if a US slowdown and a flattening of
the housing bubble will lead politicians in Congress
to start complaining about the slowdown in growth
and in jobs. Also, his true leadership and
abilities will be tested soon in 2006 when the
unsustainability of the US current account, and/or
the weakening of the US dollar and/or unexpected
episodes of systemic stress (a bursting of the
housing bubble, the increase in currently
excessively low risk premia, credit spreads and
volatility, or some large leveraged financial
institution going belly up, or a sharp fall in the
stock market) will lead to market stress and high
market volatility. He has the smarts and talents to
handle such stress episodes but the markets will
not be forgiving if he misreacts. Also, he will not
have much of a honeymoon with financial markets as
he will be regularly and continuously compared to
the "Maestro". So, savvy, transparent and clear
communication policy will be of the essence for the
Fed in the more turbulent times that we will be
facing in the future. While he favors transparency
and and flexible rules (or constrained discretion)
such as inflation targeting that provide
policy predictability, some markets participants
have had grumblings about his past statements that,
while he was Fed governor, created at
times uncertainty and had ripple effects on
bond markets (caveat: investors always complain when
they lose money because of alleged policy statement
surprises). Bernanke can succeed but markets will be
extremely watchful of every single word that he will
utter. He certainly has the skills and the smarts to
become an excellent Fed Chairman.