- The Washington Times - Saturday, November 26, 2005

For reasons that have become very clear in recent decades, the chairman of the Federal Reserve Board is widely regarded as the second most powerful policy-maker in Washington. As the leader of the politically independent central bank that oversees the world’s largest economy and whose policies directly impact the value of the world’s primary reserve currency, the Fed chairman is also reasonably considered in many circles to be the most influential economic official. Moreover, since the late 1970s, the selection of a new chairman of the Federal Reserve hasn’t happened very often.

Indeed, 10 days after delivering what critics dubbed “the malaise speech” in the summer of 1979, President Carter nominated Paul Volcker as Fed chairman. Reappointed to a second four-year term as chairman by President Reagan, Mr. Volcker served eight distinguished years. In 1987, Mr. Reagan selected Alan Greenspan to replace Mr. Volcker. Mr. Greenspan was reappointed chairman once by the first President Bush, twice by President Clinton and once by the second President Bush. His exemplary career, spanning more than 18 years as Fed chairman, will conclude at the end of January, when he completes a full 14-year term as Fed governor, a position to which he is not eligible for reappointment.

Thus, the service of only two Fed chairmen has spanned six four-year presidential terms and parts of two others. So, yes, it was a very big deal last month when President Bush nominated Ben Bernanke to become only the third Fed chairman since the final year and a half of Mr. Carter’s presidency. Given that there have been only two Fed chairmen over more than a quarter century, it is quite conceivable that the 51-year-old Mr. Bernanke, whose overwhelmingly bipartisan confirmation is a virtual certainty early next year, could be seated until 2020. With that in mind, the views he expressed during his Nov. 15 confirmation hearing and in numerous speeches since 2002 should command attention. Today, we begin a series examining those views:

• In his prepared remarks, Mr. Bernanke told the Senate Banking, Housing and Urban Affairs Committee that, as Fed chairman, he “will be strictly independent of all political influences and will be guided solely by the Federal Reserve’s mandate from Congress and by the public interest.”

• Noting that “some countries have taken a more hawkish stance in terms of putting [the control of] inflation first among equals or even first among the objectives of policy,” Mr. Bernanke assured Democratic Sen. Paul Sarbanes that, as Fed chairman, he would adhere “entirely to the [1978] Humphrey-Hawkins mandate, which puts employment growth and output growth on a fully equal footing with inflation in terms of the Federal Reserve’s objectives.”



• The issue of the Fed’s priorities arose in the context of Mr. Bernanke’s longtime advocacy of a policy in which the Fed would “state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long-term price stability.” That variant of monetary policy is called inflation-targeting. As both a leading monetary theorist at Princeton and, later, as one of seven Fed governors (2002-05), Mr. Bernanke strongly advocated inflation-targeting, which Mr. Greenspan never embraced. Having conducted monetary policy in reaction to the October 1987 stock-market collapse, the 2000-02 stock-market correction, the 1997-98 Asian financial crisis, the 1998 Long-Term Capital Management hedge-fund implosion, the 1990-91 and 2001 recessions, the September 11 terrorist attacks and the corporate-governance scandals, Mr. Greenspan understandably preferred the Fed’s implicit flexibility in the absence of an explicit inflation target.

At the hearing, however, Mr. Bernanke said he “view[ed] the explicit statement of a long-run inflation objective as fully consistent with the Federal Reserve’s current policy approach, including its appropriate emphasis on the role of judgment and flexibility in policymaking.” Not only did he insist that his inflation-targeting policy “would in no way reduce the importance of maximum employment as a policy goal”, but he justified the policy because of its potential for “anchoring long-term inflation expectations even more effectively.” In any event, the prospective Fed chairman assured the committee that he would take “no precipitate steps in the direction of quantifying the definition of long-term price stability” without further study at the Fed and extensive consultation.

• Regarding fiscal policy, Mr. Bernanke told the committee that “budget deficits are a problem” and that “it’s important to continue to reduce budget deficits.” Yet he pointedly identified what he called “important risks” to the administration’s July budget projections showing the deficit as a share of GDP declining over time. While Hurricane Katrina “obviously” will have a “near-term impact” on the deficit forecasts, he seemed particularly concerned over the projections’ longer-term “reliance for revenue on the alternative minimum tax.” Repealing the AMT, which will affect 21 million taxpayers in 2006 and 52 million in 2015, would cost an estimated $1.3 trillion in lost taxes and additional interest payments over 10 years. He said Congress will have to “consider whether either to allow the AMT to actually take effect or, alternatively, to undertake a tax reform or other measures that replace that revenue with some other form of revenue.”

• In the 2001 edition of his textbook, “Principles of Economics,” which he co-authored, Mr. Bernanke argued that “an increase in the government budget deficit… reduces public saving.” The “real [i.e., inflation-adjusted] interest rate is higher” as a result, “and both national saving and investment are lower… Reduced investment spending implies slower capital formation, and thus lower economic growth.” On this important matter, Mr. Bernanke, who has served as the chairman of President Bush’s Council of Economic Advisers since June, agrees with Mr. Greenspan.

• However, contrary to Mr. Greenspan, who frequently expressed his views on specific budget initiatives involving taxes and spending, Mr. Bernanke told the committee, “I’m going to begin now, I think, the practice of not making recommendations on specific tax or spending proposals.” Unlike our friends on the Wall Street Journal editorial page, who routinely chastised Mr. Greenspan for commenting on fiscal policy, we believe a Fed chairman’s views on fiscal policy are very important and ought to be made public. After all, the Fed must act as the buyer of last resort for Treasury securities issued to finance the budget deficit. Moreover, when the Fed monetizes the deficit by purchasing Treasury debt, it effectively prints money. That policy tends to exacerbate inflationary pressures when the economy is near full employment. Thus, with price stability in the balance, the Fed’s views on budget issues, such as discretionary spending caps and PAYGO, matter greatly. Put in place in 1990, PAYGO was allowed to lapse in 2002 despite Mr. Greenspan’s vociferous objections. In theory, PAYGO would require across-the-board spending cuts if tax reductions or new entitlement spending were not offset by increases in other revenues or cuts in other entitlements. Regrettably, Mr. Bernanke declined to express a view on PAYGO.

• Regarding the “extensive increases in energy prices” of late, Mr. Bernanke repeatedly emphasized the Fed’s indispensable role in “keeping [inflation] expectations well-anchored.” He said that the Fed’s contribution to the energy crisis would be to prevent “having those [energy] price increases spread into general inflation. Monetary policy,” he bluntly told the committee, “can’t create more energy. It can’t really solve the energy problem.”

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