Federal Reserve chairman Ben Bernanke doesn’t get much respect. PIMCO’s Bill Gross, who oversees some of the country’s biggest bond portfolios, has warned that Bernanke risks rousing inflationary dragons. NYU professor Nouriel Roubini, who correctly anticipated the 2008 financial crisis, has argued that Bernanke’s policies are failing to help the economy and are instead fueling a stock market bubble that will end in a financial crisis.
Even experts who are sympathetic have been cutting at times. New York Times columnist Paul Krugman has acknowledged that the Fed chairman is a fine economist. But his long-running disputes with Bernanke – known in some quarters as the Battle of the Beards – have included charges that Bernanke was assimilated by the Fed Borg, a reference to Star Trek’s collective alien intelligence that overwhelms individuality and personal will. Renowned investor and business magnate Warren Buffett has described Bernanke as “a gutsy guy,” but he has also criticized the Fed’s policies as brutal toward retirees, who depend on interest payments from their investments.
Indeed, Bernanke himself acknowledged as much in a 2011 press conference: “We are quite aware that very low interest rates, particularly for a protracted period, do have costs for a lot of people. They have costs for savers. We have complaints from banks that their net interest margins are affected by low interest rates. Pension funds will be affected if low interest rates for a protracted period require them to make larger contributions. So we are aware of those concerns, and we take them very seriously. I think the response is, though, that there is a greater good here, which is the health and recovery of the U.S. economy.”
It’s understandable that a public official would feel obliged to do whatever is best for the country at any given moment. If the lack of sound long-term fiscal policies is holding back growth, then up to a point the Fed can justify pumping large quantities of money into the banking system as additional stimulus. But there is a limit. In the long run, excessive money creation may engender more problems than it solves.
By compensating – or even overcompensating – for the failings of other government institutions, Bernanke has become the enabler of America’s fiscal dysfunction. The government’s tax and spending policies are way out of whack. By trying to contain the damage caused by this mismanagement, Bernanke has made it easier for the President and Congress to evade their responsibility for crafting sound fiscal policy. Thanks to Bernanke, the U.S. government has become the ultimate case of Too Big To Fail.
Nowadays commentators seem to think the Fed’s chief responsibility is to promote economic growth and bring down unemployment. But in fact, the Fed was originally created for a completely different reason – to prevent bank failures. A severe financial panic in 1907 brought many New York City banks to the brink of collapse, and a disaster was only averted because J.P. Morgan was able to pressure other bankers into raising a bailout fund.
The financial system couldn’t continue to rely on such private solutions. So in 1913, an institution was established to maintain financial reserves in each region of the country (which is why it was named the Federal Reserve, rather than the Commission for Economic Stimulus and Full Employment).
Over time, the Fed’s brief broadened to include responsibility for maintaining the stable value of paper currency. And at times, the responsibility for fighting inflation overshadowed everything else. In 1977, however, the Federal Reserve Act was amended to create the so-called Dual Mandate.
This change required the Fed to maximize employment as well as maintain the value of the dollar. Fed chairman Paul Volcker didn’t seem to feel constrained by this Dual Mandate. He raised short-term interest rates as high as 19% in 1981 to crush inflation even though unemployment was heading toward double digits.
But since then, the obligation to encourage economic growth and maximize employment seems to have become a bigger and bigger part of what’s expected from the Fed. This isn’t necessarily a bad thing. When the economy is strong, the Fed only has to worry about inflation. And when inflation is low, as is the case now, the Fed really only has to worry about economic growth. But there are two long-term risks.
The first is so-called stagflation. What does the Fed’s Dual Mandate require if inflation is accelerating at the same time that the economy is sluggish and unemployment is high? In that case, the Fed has to aim for two contradictory objectives. Taking a stand against inflation the way Paul Volcker did would risk triggering a recession. But fighting unemployment could force the Fed to turn a blind eye to accelerating inflation.
In my view there is another, less-recognized danger – a sort of fiscal moral hazard. Fixing today’s economy requires both a long-term budget plan that would bring down future deficits without excessive short-term austerity and a comprehensive plan to enhance long-term growth – by streamlining regulation, reforming the tax system, and encouraging entrepreneurs.
The biggest problem with Bernanke’s policies, in my view, is that the more he tries to compensate for the failures of other government institutions, the easier he makes it for the President and Congress to avoid coming to grips with either budget reform or a growth agenda. Bernanke may shy away from politicizing what he sees as a technocratic job. But it would be better if he were willing to be more outspoken and use the Fed’s own bully pulpit to urge necessary fiscal reforms. Just being an enabler of dysfunction does no one any favors.