Hoover Daily Report

5 Takeaways on How Bernanke Will Be Remembered

via Wall Street Journal
Thursday, December 19, 2013

1 Mark Gertler, The Henry and Lucy Moses Professor of Economic at New York University


When I first met Ben Bernanke more than 30 years ago, I did not understand his fixation with the Great Depression. Nor did I get why he was so passionate about the Federal’s Reserve’s failure in the 1930s to intervene as the economy was sliding rapidly downhill. Little did I realize that he would eventually put this knowledge and passion to use by leading the Fed’s efforts to prevent a global meltdown of financial markets, thereby saving the world economy from a second Great Depression. Fortified by his knowledge of the Depression and no doubt inspired by Franklin Roosevelt’s example of fighting the Depression with “bold experimentation,” he spearheaded an aggressive and creative mix of central bank policy interventions to restore normalcy to financial markets. And like Roosevelt, he was the calming influence — the grownup in the room — during the darkest days of the economic turmoil. His interview on “60 Minutes” in March 2009 where he reassured the nation it would emerge from the economic crisis was epic. As the rest of the government floundered (and continues to flounder) in dysfunction, the Bernanke Fed led the way out of the crisis.


How ironic that the former academic who was the world’s leading expert on financial crises, the former Fed governor who promised Milton Friedman on his 90th birthday that the Fed would never again stand by and watch the economy collapse as it did in the 1930s, would become almost by accident the chairman of the Federal Reserve on the eve of the greatest financial crisis of the postwar era. How will history remember him? He was the right man for the time.


2 John B. Taylor, The Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow at The Hoover Institution


Many will remember Ben Bernanke for classic central bank stabilizing actions taken by the Fed during the fall 2008 panic, including emergency loans to banks and swap lines to foreign central banks. But historians might also consider actions the Fed took before and after that panic.


From 2003 to 2005, shortly after Ben Bernanke joined the Board stressing deflationary concerns, the Fed embarked on a very low interest rate policy. The policy was rationalized in part by these deflationary concerns, but it was a deviation from a policy that had worked well for two decades, and it exacerbated the housing boom and led to excessive risk taking.


The inevitable bust and defaults started as early as 2006. But the Fed misdiagnosed the resulting hits to bank balance sheets as a pure liquidity problem, and its initial treatment — pouring funds into the interbank market via the 2007 Term Auction Facility — did little good. The Fed then followed up with an on-again off-again bailout policy which created more instability. When the Fed bailed out Bear Stearns’ creditors in March 2008, investors assumed Lehman’s creditors would be bailed out too. When they weren’t, it was a big surprise. With policy uncertainty reaching new heights, panic ensued.


After the panic, the Fed began to draw down the emergency loans, but it then embarked on an entirely unprecedented policy — massive purchases of mortgage-backed and Treasury securities, a tool known as quantitative easing, or QE. The economy has grown slowly with QE compared with past recoveries without QE and far short of the Fed’s predictions. Many argue that QE has not reduced unemployment, but has diminished the Fed’s independence and credibility, offsetting the effects of adopting a numerical inflation target. Now, only a year after the latest round of QE began, the Fed is struggling with how to unwind it, just as many had warned.


3 Mohamed El Erian, CEO and Co-CIO of PIMCO, the World's Largest Bond Investor


Half of Ben Bernanke’s legacy can be confidently specified at this point. The other half cannot; and how it turns out is no longer in the hands of the talented outgoing chairman of the Federal Reserve.


Mr. Bernanke’s courageous actions in 2008-09 helped the world avoid an economic depression that would have devastated millions of lives, as well as harm the prospects of the next generation. His bold design and rapid implementation of new Fed facilities succeeded in stopping cascading financial market failures, thus helping to interrupt an economic implosion and buy time for the economic system to heal.


Mr. Bernanke did more than take the Fed deep into experimental territory and to places it has never been before. He also managed to amplify the beneficial impact by thoughtfully persuading others, domestically and internationally, to do their part in implementing supportive measures.


Having succeeded in stabilizing the economy, Mr. Bernanke pivoted in 2010 from normalizing markets to assuming primary responsibility for delivering significantly higher economic growth and more dynamic job creation.


By no means was this a power grab by Mr. Bernanke. Instead, he was responding to what may be deemed a moral and ethical obligation: that of using the Fed’s policy flexibility to compensate for the inaction of other economic policy makers paralyzed by political polarization and dysfunction.


Mr. Bernanke did not make this historic pivot lightly. From the start he acknowledged that the “benefits” of greater Fed involvement came with “costs and risks.” He understood that the Fed would have to rely on imperfect and untested tools. And he acknowledged that ultimate success would require the eventual full cooperation of other policymaking entities with better tools.


Until today, the results of the pivot have repeatedly fallen short of the Fed’s own expectations. Moreover, the longer-term consequences – good and bad – remain uncertain. And there is little Mr. Bernanke himself can do at this stage to change this unsettling reality.


What eventually transpires will constitute the second half of Mr. Bernanke’s legacy. Reflecting much more than his own inputs, it will be materially influenced by how his successor, Janet Yellen, leads the Fed during an extremely tricky and complex policy phase, both nationally and globally. And it will be impacted even more by whether Congress manages to overcome its damaging dysfunction and resumes with its economic governance responsibilities.


4 Michael Bordo, Board of Governors Professor of Economics, Rutgers University and Visiting Distinguished Fellow, The Hoover Institution


During the Fed’s first 100 years, it has shifted gradually from being a banker-run to an economist-run central bank, culminating in Ben Bernanke’s assumption of the chairmanship in 2006. His appointment promised to bring the academic rigor of modern monetary economics to the chairmanship. Bernanke’s research, advocating greater transparency and better communication to enhance the central bank’s credibility, augured well for continuing low and stable rates of inflation.


Before he could address this agenda, his watch was consumed by the financial crisis of 2007-2008 and the Great Recession. Bernanke’s approach to these challenges was influenced by his research on the Great Contraction of 1929-33. He identified the Fed’s failure to counter the banking panics as the key factor that reduced the money supply and disrupted credit disintermediation, leading to massive deflation and high unemployment.


The prelude to 2007-2008 was the tech-stock bust of 2001 when Bernanke was a governor on the Fed board. Concerned about the possibility of deflation, as happened in Japan in the 1990s, he advocated a low fed funds rate from 2002 to 2006. In retrospect, this fear of deflation was overblown and low interest rates contributed to the housing boom.


Apparently conditioned by his interpretation of the 1930s, Bernanke initially viewed 2007-2008 as a liquidity crisis. Flooding the market with liquidity, the Fed was slow to recognize the underlying problems of counterparty risk and insolvency. To protect credit markets, new lending facilities were created, expanding the Fed’s balance sheet and taking on risk. Competing concerns about the prospects of “too big “ or “too interconnected” firms failing and of moral hazard led to inconsistent policy, with the government bailing out Bear Stearns, letting Lehman Brothers fail, then bailing out AIG.


By the time the crisis subsided, the fed funds rate was near zero– a lower bound that left conventional monetary policy unable to treat the still contracting economy. Purchasing long-term securities—quantitative easing—lowered longer rates but because the Fed paid interest on excess reserves, the banks were discouraged from lending, hindering recovery. These policies formulated by discretion rather than rules threaten the Fed’s credibility and independence, and Bernanke’s legacy.


5 Lars E.O. Svensson, Former Deputy Governor of the RIKSBANK


Ben Bernanke most likely saved the US and probably the world from the Great Recession turning into the Great Depression II. Trusting his judgment, his previous research on the Great Depression and on unconventional monetary policy with the policy rate at its lower bound (such as his 2004 Brookings paper with Vincent Reinhart and Brian Sack on large-scale asset purchases), he led Fed monetary policy out onto a limb to save the US economy . Without this, U.S. and world economic developments would have been inconceivably worse.


Furthermore, under Bernanke’s low-key, mild-mannered but most convincing and effective leadership, the Fed has gradually developed and improved its policy framework to become a model for the rest of the world. This included a transparent and clear interpretation of the Fed’s dual mandate of stable prices and maximum employment in the form of flexible inflation targeting, with an explicit inflation target and a balanced approach to mitigating deviations of inflation from the target and unemployment from an estimated longer-run normal rate. It also included published forecasts of inflation, unemployment, and the policy rate; with reference to these, Bernanke would at press conferences provide clear justification of the policy choice as well as honest and detailed answers to the most intriguing and difficult questions.


Finally, under Bernanke’s leadership, the Federal Reserve has learned important lessons from the financial crisis. The Fed has invested considerable resources to establish new surveillance programs to assess risks in the financial system, and the Fed has been working with other regulators to implement a broad range of reforms to mitigate systemic risk. With respect to the large financial institutions that it supervises, the Fed is using a variety of supervisory tools and indicators to assess their exposure to, and proper management of, the relevant risks. The Fed’s new policy to maintain financial stability has also become a model to the rest of the world.