Fed up with Bernanke

December 20, 2011

By Nicholas Wapshott
The views expressed are his own.

There is one thing every Republican candidate agrees on. Once in the White House, the first thing they’d do is fire Ben Bernanke. His crime is to follow the legal brief of the Federal Reserve to maximize jobs and keep prices stable. To this end he has been printing money to keep interest rates low to boost business confidence to invest and thereby create more American jobs. For many conservatives and libertarians, who dominate the early GOP caucuses and primaries, Bernanke’s cheap money policy has dangerously devalued the dollar’s worth.

Guaranteeing cheap money is a Keynesian way of restoring health to an economy in recession, though Keynes himself was aware that low interest rates do not automatically lead to jobs. However cheap money is, you can’t force people to invest. Or, as he put it, “You can’t push on a string.” He compared it to buying a bigger belt to gain weight. The fact that Keynes backed easy credit is enough to make the policy treacherous in the eyes of many con-libs. (They are far more tolerant of another Keynesian remedy–slashing taxes.)

Bernanke, however, owes his allegiance not to Keynes but to Milton Friedman. To encourage growth without hyper-inflation, Friedman prescribed gradually increasing the money supply. That way, prices would rise slowly and predictably. Bernanke is also an expert on the 1929 Crash and the Great Depression, catastrophes he, like Friedman, attribute to the 1920’s Fed keeping money too tight for too long. As Bernanke told Friedman on the father of monetarism’s 90th birthday, “You’re right. We did it. We’re very sorry. But, thanks to you, we won’t do it again.”

The legislation setting up the Fed in 1913 went out of its way to ensure that the Fed would be free of political interference so that monetary policy could be independent of politicians with short-term aims. It stipulated that the Fed should fund itself, depriving Congress of its traditional means of starving programs and institutions it doesn’t like. It gave Fed board members long terms, 14 years, with the chairman serving for four.

The sole means of influencing the Fed are through appointments and Fed board salaries. Bernanke’s current term ends in 2014* (see editor’s note), when he or his potential successor, nominated by the president, must be approved by the Senate. (The GOP candidates’ demand that Bernanke leave before his term ends would trigger an ugly constitutional crisis much like Franklin Roosevelt’s failed attempt in 1937 to pack the Supreme Court.) By demanding Bernanke’s head on a plate, however, the con-libs have served notice that the Fed’s days of independence are numbered and that every new appointment, like those to the Supreme Court in recent times, will trigger a pitched battle.

The politicization of the Fed and the arguments about its role and its future is perhaps the most significant change in a generation to the way politics is pursued. And it runs counter to best practice in other countries, where politically directed central banks have bowed to short term political demands rather than achieve long term national goals.

The decision by Gordon Brown in Britain to give the Bank of England – the UK’s Fed – its independence in 1997 was a breakthrough in good governance. Arguments over the foundation of the European Central Bank to run the euro divided between the French, who wanted a politically influenced bank, and the Germans, who insisted upon an independent body. The Germans won and the ECB has thus far resisted siren calls to print money to solve the euro crisis.

Those who are now demanding that the Fed bow to political pressure are playing a dangerous game. A politicized Fed would alternate between those who keep money cheap even in good times, stoking inflation, and those who would invite deeper recessions by depriving the system of enough money to provide adequate growth. Those who blithely demand “sound money” and the return of the dollar to the gold standard rarely explain the high price Americans would pay in terms of unemployment and the balance of trade. Nor do they spell out the ruinous inflation that would follow when their opponents took their turn at controlling the Fed.

The election in November already offers a fundamental choice between stimulus or austerity, between an active government or a shrinking state, in short between Keynes or Hayek. At one extreme lie Tea Party activists, angry that the federal government has bailed out too many people for too long; at the other Occupy Wall Streeters, who blame fat cats for the broken economy.

To the list of profound choices can be added whether the Fed should remain independent or take its lead from Congress. The attempt to politicize the Fed threatens to turn the Great Recession into a rerun of the Great Depression. That is what is at stake when Bernanke and the Fed are placed in the firing line.

*Editor’s note: This article originally stated that Bernanke had announced his intention to step down at the end of his current term. No such announcement has been made. The sentence above has been corrected.

Nicholas Wapshott’s Keynes Hayek: The Clash That Defined Modern Economics is published by W. W. Norton

PHOTO: Federal Reserve Chairman Ben Bernanke is pictured in front of a projection screen after delivering opening remarks at a conference on “Small Business and Entrepreneurship during an Economic Recovery” at the Federal Reserve in Washington, November 9, 2011. REUTERS/Hyungwon Kang


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More than “printing money,” chairman Bernanke’s answer to most sorts of economic problems is loose credit. It’s a big distinction. Loose credit stimulates more lending and more debt while printing does not. Both methods increase demand and purchasing power and are thus inflationary. Loose credit is difficult to control and to predict quantitatively because of the presence of fractional reserve banking (the money multiplier) when the economy is expanding. Loose credit has less of a stimulative effect during down times because of the liquidity trap.

The author doesn’t seem to have conceded that the 2008 financial crisis was a natural result of loose credit, credit that both increased debt and risk. It’s time to move on from Bernanke’s thesis. Friedman and Bernanke’s analysis of the Depression and its causes were substantially correct, but Bernanke’s solution is not. As Friedman so famously pointed out, the quantity of money (money stock) was a problem. However, this is problem better solved by positive money (non-debt) rather than loose credit. If you tighten credit and dissolve fractional reserve banking and offset it by adding positive money, then money is far more easily managed. Positive Money is the idea of Positive Money (UK) and a few others. They are far out in front of Chairman Bernanke (and the Republican candidates for that matter). Although Chairman Bernanke is quite smart, there isn’t any indication that he could be scholarly enough to change his thesis in the face of problematic results.

Posted by JoeHitselberger | Report as abusive

You know, the danger of short term thinking is a serious matter.
But there is also the matter of competance.
http://www.federalreserve.gov/boarddocs/ testimony/2002/20020417/default.htm
So even in 2002, the fact that Greenspan had to address the fear of a housing bubble tells me there were credible arguements for it.

http://www.google.com/search?hl=en&sourc e=hp&q=Greenspan+June+9+2005&gbv=2&oq=Gr eenspan+June+9+2005&aq=f&aqi=&aql=&gs_sm =e&gs_upl=7467l28729l0l29151l21l21l0l5l0 l0l250l2420l5.6.5l16l0&safe=active
another one.

http://www.ny.frb.org/newsevents/speeche s/2007/gei070323.html
my favorite – ask yourself this – Geithner worked at the New York fed, yet he appears clueless with regard to the dangers of derivatives.
Sure, hindsight is 20-20, but these guys are suppose to know this stuff – if they don’t, why do we listen to them?

Posted by fresnodan | Report as abusive

The Fed was politicized when it was improperly given the mandate to keep unemployment low, a mandate no central bank can accomplish without terrible distortions to the economy and eventual high unemployment; see the last twenty years of boom and bust bubbles brought to us courtesy of a Fed trying to manage the business cycle as an exmple.
Moreover the unemployment mandate is often in direct opposition to the more important and achievable mandate of a stable currency. So the already accomplished politicization of the Fed has brought us the worst of all possible worlds.
That the ineptitude of the Fed and the improper role it has been given leads people to wish to get it under control should not be surprising.
What should be surprising is that people are still defending its utter incompetence and chaotic policies which, except for the short time of the Volcker/Greenspan period from 1980 until the S&L crisis of the late 80’s, has been fairly disastrous since the early seventies when the last link to gold was severed by Nixon and Arthur Burns and company began the decades of roller coaster inflation/deflation and asset bubbles we’ve been plagued with.
By the way very few people, left, right or center, Keynesian, classical, supply side, Austrian, whatever, subscribes to the monetarism of Friedman anymore. He was a brilliant man who made many brilliant points especially in critique, and was basically correct about freedom and free markets, but research has called into serious doubt a lot of his monetarist theories including those about the depression.

Posted by mudpuppy | Report as abusive

Given Wapshott’s recent book his opinions here seem odd.

Bernanke has clearly failed at least in part due to his reliance on Keynesian assumptions. He did not take action to prevent the credit bubble from forming, did not even see the downturn, and when it did arrive failed to understand just how bad it really was. He continues to use methods and tools that are purely Keynesian that those influenced by Hayek would naturally object to and rightly fear.

I’m skeptical of assertions that but for his interventions all would be lost.

So given Bernanke’s record that he should be removed is hardly politicizing the Fed.

Further, a review of the views of the current Board at the Fed reveals a preponderance of people holding similar views as Bernanke. That this imbalance should be corrected with the adding to the Board of people sympathetic with the Hayekian point of view would also seem not to be so much politicization as restoring sound management.

Posted by Otiose | Report as abusive

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