The Villain

The left hates him. The right hates him even more. But Ben Bernanke saved the economy—and has navigated masterfully through the most trying of times.

Even rightward-leaning economists mostly give Bernanke a pass on his actions during the financial panic itself. The fog of war was pretty intense, and he avoided losing taxpayer money. But in the second stage—resurrecting the economy, and potentially tinkering with the inflation rate—he has taken heat from thinkers on both sides of the aisle. Even the Fed’s Open Market Committee, the group that sets interest-rate policy, is splintered. In the Greenspan era, especially as the chairman’s aura grew, this body spoke with one voice, rubber-stamping whatever the chairman wanted. Bernanke’s committee is a monetary Babel—partly because he is open to hearing contrary opinions, and partly because opinion is so deeply divided. While Greenspan withstood a dissenting vote here or there, Bernanke has suffered 32 nay votes, including three dissents in a single meeting. That hadn’t happened in 20 years.

Most of Bernanke’s dissenters are hawks, but Charles Evans, president of the Federal Reserve Bank of Chicago, has dissented twice because he thinks the Fed should be willing to tolerate a higher rate of inflation until the job market recovers. Janet Yellen, the Fed’s vice chair, and William Dudley, president of the New York Fed, also lean toward increased stimulus. No previous Fed chief had to deal with such an internal crossfire.

Bernanke’s quandary derives from the fact, unusual among the world’s central banks, that the Fed has a “dual mandate”—by law, it is required to promote “maximum employment” and also “stable prices.” The European Central Bank, by contrast, is supposed to worry only about inflation. This is why the latter twice raised interest rates in 2011, when Europe was teetering at the edge of recession and possibly default.

The formative experience for the European Central Bank was the hyperinflation in Germany in the 1920s, which ever since has steeled central bankers on the Continent against the perils of printing money. In Frankfurt, the idea of “lender of last resort” wasn’t, and isn’t, embraced. For the U.S. Federal Reserve, the formative experience was a series of depressions beginning in the 19th century and culminating in the Great Depression. After the demise of Biddle’s bank in the 1830s, “money” in the U.S. consisted of whatever notes banks printed and people agreed to take. Even after the Civil War, when “money” became more uniform, currency was often a scarce commodity, and banking panics were frequent.

The Fed was conceived, in 1913, as a backstop to the financial system. “Printing money”—the accusation that Rick Perry leveled against Bernanke—was part of the job description from the outset. Currency still consisted of banknotes, only now the bank was the Federal Reserve. The Fed seemed to fulfill its promise during World War I, pumping hundreds of millions of emergency dollars into the financial system. During the Depression, for reasons that are still being debated, it failed. Bernanke clearly has avoided the worst mistakes central banks made in the Depression. Yet unemployment remains high, raising questions from some economists, especially on the left, as to whether the Fed has done enough.

Bernanke, for the most part, has kept inflation in the range of 2 percent a year, which is where he wants it—not so high that it would threaten an inflationary spiral, but high enough to provide a cushion so that policy makers can react if inflation shows signs of ebbing and deflation looms. Krugman and others argue that the Fed should encourage faster inflation to address persistent high unemployment. This argument operates on several levels. Printing money, of course, does not create jobs. But because wages are “sticky,” higher prices for goods can make labor more affordable to employers. When times are tough, McDonald’s, for example, has no qualms about cutting hamburger prices, but it is less likely to cut pay. Instead, it employs fewer workers. (This is why the economy lost 8.5 million jobs during the recession; there is a very strong social bias against asking workers to go “on sale.”) Inflation is a less visible way of reducing pay. Workers think they are making the same amount, but since the dollars are worth less, employers can better afford to pay them.

The second way in which inflation could help the economy is that it makes borrowing and spending more attractive (debtors can repay their loans in cheaper dollars). For the same reason, inflation is a boon to people already in debt—people with mortgages, for instance. By hastening the “deleveraging” of American households, the argument goes, inflation could unlock the housing market and also return us more quickly to more-normal spending and employment patterns. Kenneth Rogoff, a Harvard economist who once worked at the Fed, has suggested that Bernanke try to raise inflation into a range between 4 and 6 percent.

There are very good reasons to be wary of such a prescription. Just as inflation helps debtors, it hurts creditors. Banks and bondholders get cheated, because their loans are repaid with inflated coin. Similarly, people with fixed savings, such as retirees, get punished for their thrift. President Grover Cleveland, a warrior against inflation (in his day, brought about by cheap silver), rightly likened a debasement of the currency to theft. Of course, someone also benefits from this theft—in Cleveland’s era, farmers seeking higher prices; in ours, the unemployed. The latter are hardly to be blamed for being jobless, but helping them involves a trade-off that creates losers as well as winners. And the trade-off is only temporary. Eventually, wages catch up with money creation. Once the economy is operating at its potential, dropping money from the sky will not add jobs. It will keep causing inflation.

Bernanke has given serious thought to the Krugman-Rogoff argument. One obstacle is practical. Fed policy works, in part, by getting the market to do the Fed’s work (if the Fed is buying bonds, traders who want to be on the same side of the markets as the central bank will buy bonds too). But any policy adopted by less than a 7-to-3 majority by the Fed’s Open Market Committee would not be viewed by markets as a credible policy, likely to endure, and Bernanke is not guaranteed to get this margin today. “No central banker would do it,” Mankiw says of raising the inflation target; the political reaction would be too severe. (When Mankiw, a Harvard economist, wrote a column raising the possibility of a higher inflation target, Drew Faust, the university’s president, received letters urging her to fire him.)

This might seem to support Krugman’s thesis that Bernanke would like to boost inflation but has chickened out. But after talking with the chairman at length (he was generally not willing to be quoted on this issue), I think that, although Bernanke appreciates the intellectual argument in favor of raising inflation, he finds more compelling reasons for not doing so. First is the fear that inflation, once raised, could not be contained. The Fed creates inflation by adding reserves to the banking system (falling interest rates are the market’s way of registering the increasing plenitude of money). If so much money enters the system that wages and prices start ratcheting upward, the momentum can be self-perpetuating. “The notion that we can antiseptically raise the target and control it is highly questionable,” Bernanke told me.

Second, raising inflation is not always so easy. Inflation does not go up by fiat—by edict of the central bank. Rather, the Fed has to persuade millions of people to spend more money and tens of thousands of businesses to raise their prices. And this will not happen if people think the monetary easing is temporary. Money comes from credit, and borrowing depends on expectations for the future. The theoretical point is that the market sets long-term interest rates to reflect the sum of expected future short-term rates. So the way to reduce long-term rates is to convince people that short-term rates (which the Fed controls) will stay low for an indefinite period. As Bernanke is well aware, this problem has generated an extensive literature, the gist of which is that the Fed would have to promise to be, in effect, “irresponsible.” In other words, the Fed would have to say, “Even when prices start rising, even when inflation starts to get out of hand, we will still keep rates near zero.” That is what sparked the inflation of the ’70s: people thought inflation was permanent, and a borrow-and-spend mentality set in. If Bernanke were to re-create that climate, it would be hard to shut down.

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