Bernanke's Fed as told by Ethan Harris

Ben Bernanke's Fed: The Federal Reserve After Greenspan by Ethan Harris is a very informative book on the mind and behavior of Ben Bernanke. It is in simple prose from a strong business economist. Even the complex issues of monetary policy are clearly describe for any business reader. Harris spends time setting the stage through a discussion of macroeconomics and how the Fed works with a focus on the financial accelerator model which was developed by Bernanke. The channels of monetary policy are especially critical for understanding the current crisis. He explains the politics of the Fed. The Fed tries to protect its independence at almost all costs. This has meant a lack of clarity on what it is doing to the economy through an approach of constructive ambiguity.

Harris does a good job of describing the ambiguity of policy that is desired by central bankers to remain independent and have flexibility with their policies. While Bernanke has made efforts to reduce this uncertainty, he still falls into the camp of trying to be obtuse. 

But, there is a long history of this behavior. Asked for his reasons for his decisions, Montague Norman, governor of the Bank of England before WWII replied, "Reasons, Mr Chairman? I do not give reasons. I have instincts". 

Mervyn King once asked Pal Volcker if he had advice for a new central bankers. His answer was one word, "mystique." 

After questioning Volcker at a hearing in 1980, one congressman remarked "You would make an excellent prisoner of war because you would not tell the enemy anything." 

Former Fed Governor Larry Meyer says, "reading the Chairman's speeches and testimony was a bit like reading the children's book Where's Waldo?" He also said "One of my most prized possessions is my Greenspan decoder ring." 

Alan Greenspan quotes: 

"If I seem unduly clear to you, you must have misunderstood what I said." 

"I have learnt to mumble with great incoherence." 

"I spend a substantial amount of my time endeavoring to fend off questions and worry terribly that I might end up being too clear". 

"I'm trying to think of a way to answer that question by putting more words into fewer ideas than I usually do."

However, the Fed has taken measurable steps to provide transparency despite all of the jokes, including: 

Nov, 1993 - releasing transcripts of FOMC meetings with 5-year lag 

Feb, 1994 - announcing policy changes 

May, 1999 - reveal policy bias 

Feb, 2000 - indicate whether growth or inflation is greater risk 

Mar, 2002 - add vote to directive 

May, 2003 - separate up/down risk for growth and inflation 

Aug, 2003 - forward-looking language 

Feb 2004 - release minutes before next FOMC meeting.

Bernanke has had the difficult job of following Greenspan even with the more tarnished image that currently paints the former Chairman; nevertheless, it would be a mistake to believe that Bernanke is the same person. There are four major policy objectives of Bernanke. All of these beliefs have been influenced by his monetary research. First, Bernanke is interested in better communication and moving toward inflation targeting. Bernanke may be one of the leading researchers on the topic of inflation targeting. Second, Bernanke has been greatly influenced by the behavior of the Fed during the Great depression and the behavior of the BOJ during its lost decade. Monetary policy should be used aggressively when needed. Third, a greater reliance on statistical modeling will better drive policy decisions. Fourth, a risk management approach during crises will solve problems with strong action. 

Bernanke is a strong proponent of inflation targeting. That view still applies even under the current environment when prices are falling. Policy steps should be used to get inflation higher. Nonetheless, the Fed has a dual goals so it has been more difficult to focus solely on price inflation. Hence, the language of the Fed now includes OLIR, the optimal long-range inflation rate and MCIR, the Mandate-consistent inflation rate. These targets will be consistent with NAIRU, the non-accelerating inflation rate of unemployment. Clearly, these targets are consistent with an inflation target even if they are not called by that name. 

Bernanke has been a keen researcher of the Depression. His recommendation to Japan on what should be done in a depression earned him the name of Helicopter Ben. In short, Bernanke is not going to allow a depression on his watch because of too tight monetary policy. His policy approach to deflation is very clear. Push rates to zero. Lower long-rates through quantitative easing. Push down private rates through purchases in the market. Intervene in currency markets to weaken the dollar. Coordinate fiscal and monetary policy. Sounds like he is following the script he recommended to Japan pretty closely.

One of the key differences between Bernanke and Trichet at the ECB is the potential response to asset bubbles. Because it is difficult to identify and pop bubbles, Bernanke would prefer to act in a risk management or defensive role. The current question will be the role of the Fed as a regulator who has responsibility for systemic risk and potentially stopping bubbles before they occur. 

So how has Bernanke done at the helm since Feb 2006? We can clearly say that he has stayed consistent with his research findings and principles from his academic days. He has been more communicative. He has been aggressive at using monetary policy. He has been effective at using staff to get different opinions and he has moved up the curve with regulatory issues. Did he make all of the right choices and communicated his intentions perfectly? No, but he has done better than what those who thought he would be a weak academic chairman. This opinion is coming from a leading business economist.