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On the Reappointment of Ben Bernanke
Nouriel Roubini | Aug 25, 2009
A month ago - when the debate on Ben Bernanke’s potential reappointment as Fed chairman was still in its early stages - I wrote an
op-ed for The New York Times supporting Bernanke’s reappointment.
This support was not unconditional. Bernanke and the Fed made many mistakes early on. They missed signs of the economic and financial tsunami and until the summer of 2007 they lagged in their policy response. As I put it:
To be sure, an endorsement of Mr. Bernanke’s reappointment comes with many caveats. Mr. Bernanke, a Fed governor in the early part of this decade, supported flawed policies when Alan Greenspan pushed the federal funds rate (the policy rate set by the Fed as its main tool of monetary policy) too low for too long and failed to monitor mortgage lending properly, thus creating the housing and credit and mortgage bubbles.
He and the Fed made three major mistakes when the subprime mortgage crisis began. First, he kept arguing that the housing recession would bottom out soon (it has not bottomed out even three years later). Second, he argued that the subprime problem was a contained problem when in reality it was a symptom of the biggest leverage and credit bubble in American history. Third, he argued that the collapse in the housing market would not lead to a recession, even though about one-third of jobs created in the latest economic recovery were directly or indirectly related to housing. Mr. Bernanke’s analysis was mistaken in several other important ways. He argued that monetary policy should not be used to control asset bubbles. He attributed the large United States current account deficits to a savings glut in China and emerging markets, understating the role that excessive fiscal deficits and debt accumulation by American households and the financial system played.”
Still, I argued that Bernanke’s aggressive policy actions had prevented another Great Depression:
“Mr. Bernanke deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0.
Mr. Bernanke understands that in the Great Depression, the collapse of the money supply and the lack of monetary stimulus during contractions worsened the country’s economic free fall. This lesson has paid off. Mr. Bernanke’s decision to keep interest rates low and encourage lending has, for now, averted the L-shaped near depression that seemed highly likely after the financial collapse last fall….
…when a liquidity and credit crunch emerged in the summer of 2007, Mr. Bernanke engineered a U-turn in Fed policy that prevented the crisis from turning into a near depression. He did this largely with actions and programs that were not in the traditional toolbox of monetary policy. The federal funds rate was effectively pushed down to zero to reduce borrowing costs and prevent the collapse of consumer demand and capital spending by business. New programs encouraged skittish institutions to resume lending. For the first time since the Great Depression, the Fed’s role as lender of last resort was extended to investment banks.
Mr. Bernanke also introduced a wide range of other programs, like those to maintain the functioning of the commercial paper market (which makes short-term loans to companies so they can cover operating expenses like payrolls). The Fed was involved directly in the rescue of financial institutions like Bear Stearns and American International Group. It lent money to foreign central banks to ease a global shortage of dollars. The Fed even committed to purchasing up to $1.7 trillion of Treasury bonds, mortgage-backed securities and agency debt to reduce market rates. These are all radical actions that had almost never been undertaken before.
…the basic point remains: The Fed’s creative and aggressive actions have significantly reduced the risks of a near depression. For this reason alone Mr. Bernanke deserves to be reappointed so that he can manage the Fed’s exit from its most radical economic intervention since its creation in 1913.”
I also pointed out that the Fed actions leave open many difficult questions, especially those regarding the exit strategy from this unprecedented monetary easing:
“Some of these moves have raised important questions: Did the Fed help bail out institutions that should have been allowed to fail? Did it cause moral hazard as reckless lenders and investors were effectively bailed out? How and when will the Fed mop up the excess liquidity that its actions have created? Will these actions eventually cause inflation and a sharp fall of the value of the dollar? Has the Fed lost its independence as it has accommodated the fiscal needs of the government by bailing out banks and printing money to cover large fiscal deficits?”
These difficult issues need to be addressed, and the consequences of the Fed’s actions – especially its bailouts of financial institutions that should have been left to enter bankruptcy – will have implications for decades to come. Bernanke justified these bailouts by saying he undertook them only to prevent a meltdown on Wall Street that could have led to a collapse on Main Street:
“I was not going to be the Federal Reserve Chairman who presided over the second Great Depression, I had to hold my nose and stop those firms from failing. I am as disgusted about it as you are.”
More importantly, the Fed and the Treasury will now have to navigate between Scylla and Charybdis—attempting to formulate an exit strategy from massive monetary and fiscal stimulus without sinking U.S. economic prospects. As I said
in my FT op-ed yesterday and in a
longer research piece last week, they may be “damned if they do and damned if they don’t”:
“If they take large fiscal deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stag-deflation (recession and deflation).
But if they maintain large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.”
So we wish the Fed and the US Treasury the best in navigating these treacherous policy straits. If a serious policy mistake is made, the economy could double dip: exiting too early will bring us back to stag-deflation; exiting too late will lead us to stagflation. The policy path that avoids both pitfalls is extremely narrow.
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