My editor asked for a column on the changing of the guard from Alan Greenspan to Ben Bernanke. So that’s what he got.
Bernanke Handover: So far so good.
It’s a tried, tested and trusted truism that generals fight the last war. But some generals have the insight and courage to build on, rather than be enslaved by past battles.
January 31 sees the retirement of one such economic general, Alan Greenspan, Chairman of the US Federal Reserve America’s central bank. And he may be handing over to someone of similar quality. So far so good. But, it’s too early to be sure that Greenspan’s success is as great as it looks. Let me explain.
After the 1970s’ disastrous combination of inflation and unemployment, fighting inflation was all the rage. Greenspan’s predecessor Paul Volker slew inflation by engineering a savage recession in the early 1980s. Greenspan helped entrench Volker’s achievement of low inflation but treated it as a precondition of maximising long-run growth, not as an end in itself.
The share-market crash of October 1987 was Greenspan’s baptism of fire just two months into his chairmanship. His insistence that the Fed stood “ready to provide all necessary liquidity” and his cutting interest rates indicated changed priorities. In this new war low inflation could be presumed for the time being whilst easier money warded off recession and financial instability.
In the 1990s, against advice to choke off additional growth, Greenspan argued (it turned out correctly) that official numbers underestimated productivity growth from the ‘new economy’. Greenspan went for growth and created millions of jobs whilst keeping a weather eye out for signs of inflation.
While the US Fed and the world’s other great central bank our own were going for growth without re-igniting inflation, other central banks followed the academic fashion of the time, insisting that entrenching price-stability exhausted their macro-economic responsibilities. New Zealand after the Asian crisis, and Europe and Japan more generally condemned their own countries to lower growth and thus, to millions fewer jobs.
In the 2001 downturn in the wake of the ‘tech-wreck’ Greenspan cut rates once again, and once again eased the pain without re-igniting inflation.
But the news wasn’t all good. Monetary policy works slowly and unevenly which makes occasional misjudgments inevitable. Greenspan somewhat misjudged the aftermath of his own easing in 1987. He tightened too late and too much producing the downturn of 1990.
He famously warned about markets’ ‘irrational exuberance’ in 1996 and then mysteriously went on to cheer-lead for the ‘new economy’ as it hurtled towards the ‘tech-wreck’ of 2000.
And as his prestige grew he occasionally lapsed into brazen partisanship lecturing Bill Clinton on the importance of fiscal rectitude and then endorsing George W. Bush’s profligate tax cuts and his social security scare-mongering.
The borrowing binge he set off to fight the last recession helped fill in an economic pot-hole. But such aggressive use of monetary policy can misallocate investment and increase economy-wide risks. Greenspan’s success has left the US economy with some very dangerous shoals to navigate.
The Fed has gradually increased short-term interest rates to much more normal levels without triggering any crises. So far so good. But the tax cuts Greenspan helped Bush introduce have helped swing the budget from surplus to hefty deficit and helped drive the US to increase its foreign borrowing by the best part of a trillion dollars each year much of which just drives up real estate prices (sound familiar?).
So we’re not out of the woods yet.
Enter new Chairman Ben Bernanke. We don’t know how much of a handicap his relative lack of practical experience in Washington and on Wall St will be nor whether he’ll have Greenspan’s superb economic judgement.
But we do know this. As one of the world’s leading monetary economists he has spent recent years focusing on the very problems he’ll be having to deal with rather than re-fighting old battles. He’s published on how policy should respond to asset booms (like the previous stock market bubble and the current US housing market), how to tackle deflation should it take hold, and been at the forefront of thinking about Asia’s role in driving foreign deficits in the US and elsewhere by exporting its ‘excess savings’.
Like Greenspan, Bernanke says “low and stable inflation is the bedrock of sound monetary policy”. But he’s also alive to the dangers of too single minded fixation on fighting inflation. Like Greenspan he’s prepared to be unconventional to keep growth going having spoken about printing money if it were necessary to ward off deflation.
And I can count three dissimilarities to Greenspan all improvements on the original! Bernanke is a quiet consensus builder with plenty of cred to do it, where Greenspan was more mercurial and autocratic. Bernanke strives for clarity, where Greenspan’s role model was the oracle at Delphi. And though he’d never have gotten the gig if he wasn’t a Republican, colleagues report Bernanke as being reticent about political partisanship.
So far so good.