My sense is that Bernanke is too much a sober central banker to want to risk the Fed’s credibility on inflation. His view represents a serious break from many of his fellow academics because, according to the world as left-leaning scholars depict it, raising inflation is the only thing that will work when the economy has hit dead air. Bernanke thinks he has other tools. One, of course, is quantitative easing. Instead of lowering expectations for short-term rates, which is how the Fed usually operates, quantitative easing involves direct intervention in the long-term sector of the credit market. By purchasing long-term securities, the Fed aims to reduce the cost of mortgages, corporate debt, and so forth. Working on long-term interest rates is a natural move, because short-term rates are already near zero. But whether quantitative easing has much impact is hotly debated. The policy was clearly effective during the early stages of the mortgage crisis, when it helped to unfreeze credit markets, enabling companies and individuals to get loans again. However, even Bernanke’s supporters admit that since these markets have begun functioning again, continued purchases of long-term bonds have had only a modest effect. Mark Gertler, an economist at New York University and a friend of Bernanke’s, says the second round of quantitative easing might have moved the needle by perhaps a quarter of a percentage point. He nonetheless credits this policy with keeping inflation from sagging dangerously low—“not a trivial accomplishment.” The Fed also seems to have accelerated last year’s spike in the price of gold, oil, and other commodities. And that, to conservatives, is just the problem.
The critique from the right is that the continued steps to stimulate the economy are both unnecessary, given that the financial crisis has passed, and inflationary. Allan Meltzer, an economist and historian of the Fed, says Bernanke is trying to do what is beyond his powers. “The current high unemployment is not a monetary problem,” Meltzer says, meaning we are past the point where further rate cuts will stimulate hiring. Bernanke has been accused of trying too many remedies with poor odds of success. Possibly, he would plead guilty to this. He has said he admires Franklin Roosevelt’s catchall approach to fighting the Depression, which was less an ideology than an enthusiasm for enthusiasms. The fear now is that the Fed’s balance sheet—that $2.9 trillion—represents kindling for inflation that one day will catch.
The mechanism for ignition would be as follows: Each time the Fed purchases a Treasury security or a mortgage-backed bond, it credits the selling bank with a “reserve” in the same dollar amount. Bank reserves exist as electronic notations, but they represent real money available for loans, and much of that money is sitting idle today, partly because loan demand is weak. If banks, presently, were to lend all their excess reserves, say in the form of cash, the supply of currency would nearly triple overnight, and the price of a burger would, you can bet, do the same. And if the Fed were faced with such an onslaught, and chose to soak up the excess reserves by quickly selling its assets, the deluge would overwhelm markets, send interest rates soaring, and snuff out the recovery.
Bernanke has thought about this—in fact, he has been thinking about how to exit from quantitative easing almost from the day he began it. In 2008, he asked for and received expedited authority from Congress to pay interest to banks on their reserves. Currently, the rate is 0.25 percent. But let’s say loan demand picks up (as has recently been the case, albeit slowly)—and therefore banks can profitably lend at a higher rate. The Fed will be free to raise its interest rate, tempering the rate of new lending by inducing the banks to keep some of their reserves parked—happily and idly—at the Fed. In plain English, Bernanke plans to reward the banks for keeping some of their money inert, which will give him time to unwind the balance sheet gradually. No one knows whether this gamble will work.
Still, the Fed has always faced the challenge of tightening credit after a period of ease. The fact that it has been accumulating long-term bonds rather than short-term bills is a relatively benign innovation, less exotic than many observers have claimed. So far, the hawks have seen inflation around every corner. So far, they have been wrong, and Bernanke has been right. The reasons critics so hate quantitative easing, I think, have less to do with the mechanics of bank reserves and more with nostalgia for a more cautious, and more tradition-bound, Federal Reserve. Quantitative easing’s critics want the Fed to be leaner and less activist. They want consumers to reduce their debts, not to borrow and spend anew, and they fear that quantitative easing will create a new consumption bubble. Bernanke, in fact, has been facile on this point; he told Congress in February, “Our nation’s tax and spending policies should increase incentives to work and save,” but his nearly zero percent interest rate clearly discourages saving.
The Fed’s purchases of mortgage-backed securities are controversial for a different reason. Critics charge that they are outside the Fed’s charter. Bernanke hopes such purchases will lower mortgage rates, revive housing, and create jobs in construction. But any government investment that favors the housing industry necessarily disfavors aerospace, retail, and everything else that is not housing. Jeffrey Lacker, the hawkish president of the Federal Reserve Bank of Richmond, says this is credit allocation, not monetary policy. The Fed, he fears, is too much in agreement with the executive branch; elected politicians can throw the kitchen sink at mortgages, but neutral, unelected central bankers should not. And Warsh, the former Fed governor, who was a vigorous, if disputatious, ally of Bernanke’s during the crisis, says the Fed should not be a “repair shop” for a broken fiscal policy, an auxiliary arm of a dysfunctional Congress. Warsh told me that the Fed’s continued interventions have fogged up the dashboard and blurred the signals of the private sector. “We have been trying to fake a housing recovery for four and a half years,” he says, meaning that each Fed purchase elevates the market above its inherent level.
By this thinking, bankruptcies and foreclosures play a restorative role—returning assets to the market newly unleveraged and reasonably priced. The argument has emotional—almost religious—appeal, the downward repricing of assets being the market’s form of atoning for sin. Bernanke encountered this idea in November, when he visited military families at Fort Bliss, in El Paso. A woman asked him whether “we should be looking to get ourselves back to where we were … when it comes to how people live, buy homes, save, invest.” The chairman drew a breath and acknowledged, “That’s a very deep question.” His answer was revealing. While insisting he has no wish to return to overpriced homes and lax mortgage standards, he added, “I’m not a believer in the Old Testament theory of business cycles. I think that if we can help people, we need to help people.”
I pushed him, in one of our interviews, to elaborate, and he said, “There is a thesis that the only way to restore the economy is by a necessary purging of previous excesses. In disagreeing, I am not saying there are not imbalances that need to be fixed. That said, there is still scope for policy to ameliorate the effects of necessary rebalancing on the public, to help shorten the recession. A massive decline in employment slows the rebalancing and deleveraging processes rather than speeds them; people don’t have the income to pay their debts. So the argument is: where you can, you try to short-circuit the process by urging banks to take losses and modifications, and recapitalize. Obviously, you need to get bank balance sheets healthy, and individual consumers healthy—but subjecting the system to high unemployment and high rates of bankruptcy and foreclosure is a very inefficient way to get there.”
Bernanke is more conservative than his Republican critics imagine, but as he has stated publicly, he finds the prospect of millions remaining unemployed “unacceptable.” He is particularly worried about the many people who have been out of work for more than six months. Like FDR, he is willing to try what works, or what might work, and this puts him at odds with the economic originalists. He sees no evidence of inflation, but he does see economic distress, and so the latter is a greater concern. Though he recognizes the potential for inflation, he told 60 Minutes in December 2010 that he was “100 percent” certain of his ability to control it (a surprising, and troubling, certitude for a normally humble banker). When I brought up the argument that the purchase of mortgage-backed assets—inflationary impact aside—amounts to inappropriate “credit allocation,” Bernanke gave a tired frown, as if the fine points of monetary theory cannot hold water against the concrete fact of unemployment. “I would argue the mortgage-backed securities we purchased probably moved the market closer to an efficient state rather than away from it,” he told me.
Apart from his direct interventions in the market, Bernanke is also doing more to communicate the Fed’s intention to keep rates low, and publicizing the circumstances that would cause the Fed to start raising rates. Late last year, the Fed committee that sets overnight short-term interest rates took a small step by announcing that it will make public not just the current rate, but its members’ future expectations for this rate. Then in January, fretting over the drag on the economy stemming from Europe, even as green shoots were sprouting in America, the committee took a big step. Although it had previously predicted that rates would stay near zero through the middle of 2013, now it forecast that rates would remain very low all the way through the end of 2014. Significantly, Bernanke said he could live with inflation’s moving a bit higher for a while if that would help bring unemployment down. “We’re not absolutist,” he said in a news conference, sounding every bit a Rooseveltian. The following week, when Bernanke testified on Capitol Hill, Paul Ryan, the House Budget Committee chairman, pressed Bernanke: “It seems as if you’re moving away from an inflation target … that the Fed is willing to accept higher levels of inflation in order to chase your employment mandate.” Bernanke denied this. Two percent was still the target, he said, but it’s the target over the medium term. “Monetary policy,” he noted, “works with a lag. We can’t achieve it every day, every week, but over a period of time we want to move inflation always back towards 2 percent. We will not actively seek to raise inflation.” No Fed chief had ever been so explicit about his inflation target before.
Bernanke’s emphasis on transparency rests on the notion, dear to modern financial economists, that people rationally adjust their behavior in line with expectations; thus, the Fed’s predicting a market outcome can help make it so. That may be partly true, though the theory is far from perfect. First, people do not always respond rationally to information. Second, the Fed has been poor at forecasting the state of the economy, so the public might just disregard its predictions and the policy expectations that result from them. Bernanke’s January forecast that the economy will remain weak, and need prolonged resuscitation, could be off base. Even if he has lately developed clairvoyance, his term expires in January 2014; the market is unlikely to credit his power to forecast policy for the year after he leaves office. (It remains possible that President Obama, if reelected, would reappoint Bernanke to a third term.)
The Fed, in January, also said it will consider resuming bond purchases if the recovery loses steam. That prospect will be a subject of intense speculation among the monetary cognoscenti, but it must be admitted that in general, each round of quantitative easing has had diminishing returns. A next round, if it occurs, is likely to have less impact still. In short, even the imaginative and innovative Bernanke is close to having exhausted his options. Credit is flowing; short- and long-term money is cheap; and the economy is improving. The IMF’s Blanchard, who studied with Bernanke at MIT, recently told me, “I think he has done what he can do. One has to accept that ‘not enough’ is enough.”
Bernanke’s conception of the central banker’s job, Blanchard pointed out, has been fuller, more comprehensive, than that of their fellow bankers in Europe. Indeed, the European Central Bank has lately begun to mimic the Fed’s approach to its own crisis. By mid-winter, U.S. unemployment had fallen to its lowest level since the end of the recession. Almost certainly, Bernanke will leave office with the United States in better shape than the Continent.
Ultimately, Bernanke’s legacy will depend on whether he can fully exit from the mortgage debacle without bequeathing a new one, or lighting an inflationary fire that becomes uncontainable. Alan Greenspan retired as the prince of central banking, but saw his reputation wither because of the bubble that burst on Bernanke’s watch. In office, Paul Volcker was highly controversial because of his hawkish policies; today he is practically canonized. Vincent Reinhart, who served under both Greenspan and Bernanke as the senior monetary deputy and is now retired, told me I was writing about Bernanke “five years too early.” For sure, no one knows where either inflation or unemployment will be in five years’ time. Forgoing a guess, I would offer the appraisal by Hank Paulson, the former treasury secretary, who told me recently: ”I don’t know what people expect Ben to do. To me, it’s pretty amazing. Who would have guessed when he came to Washington we would be so fortunate to get someone who was willing to think outside the box and deal with this unprecedented crisis?”
The visceral criticism of Bernanke is hard to fathom, but it is in part the flip side of the enormous trust that we are asked to place in the modern Federal Reserve. At least in the time of Nicholas Biddle, and even during the formative years of the Fed, banknotes, being liabilities, could be redeemed for something of value, usually gold. Now our dollars are exchangeable only for more dollars. This is what alarms the originalists. As the publisher, Bernanke critic, and gold bug par excellence James Grant eloquently put it, “We have exchanged the gold standard for the Ph.D. standard, for soft central planning.”
Originalists who are unhappy with quantitative easing are unhappy with elastic currency and with fiat money itself; nothing but gold will do. This has been true, of course, for 40 years—since the U.S. went off the gold standard—but only Bernanke has had to implement with such vigor the Fed’s original missions of “lender of last resort” and “coiner of an elastic currency.” And he is up there now, in the helicopter, showering us with money, as the Fed didn’t do but should have done in 1933. Yet even as this comforts, it elicits in most of us a spasm of wonder, or anxiety, that a single Ph.D. or a building full of them could calibrate such a mystery as the proper quantity of money, particularly in an economy as dynamic as ours is today. Bernanke does not use gold as a measuring stick; he does not count the money in circulation as a basis for determining interest rates, as Volcker did, or tried to do. His mentor, Milton Friedman, thought the business of adjusting interest rates was so tricky, it would be better to yield the job to a computer. But Bernanke thinks a human can do it. He sticks to his notion of what inflation should be, and his prediction of where it is headed, trusting that his judgment will tell him when to add more liquidity, when to subtract. And, to a greater extent than he is credited with now, history may marvel that Bernanke has been a success.