October 24, 2005

Bernanke to be Next Fed Chairman

CNN reports President Bush will name Ben Bernanke as the next Federal Reserve Chairman to replace Alan Greenspan. Unlike Harriet Miers Bernanke won't be labled as a Bush crony. The unsurprising pick (he's been mentioned many times as Greenspan's replacement) worked at the Fed before as well as in academia. Currently he's the chairman of the Council of Economic Advisors.

On the plus side he's an inflation hawk like Greenspan. He's in favor of something called "inflation targeting." Here's what he told the Minneapolis Fed:

It's true that the Federal Reserve is already practicing something close to de facto inflation targeting, and I think we've seen many benefits from that. My main suggestion is to take the natural next step and to give an explicit objective, that is, to provide the public with a working definition of price stability in the form of a number or a numerical range for inflation. I believe that that step, though incremental, would have significant marginal benefits relative to current practice.

First and very importantly, such a step would increase the coherence of policy. Currently, the FOMC [Federal Open Market Committee] makes its decisions without an agreed-upon definition of price stability or of the inflation objective, and one wonders how oarsmen pulling in different directions can get the boat to go in a straight line. I think the FOMC's decision-making process would be improved if members shared a collective view of where we want the inflation rate to be once the economy is on a steady expansion path.

Second, there's a great deal of evidence now that tightly anchored public expectations of inflation are very beneficial, not only for stabilizing inflation but also in reducing the volatility of output and giving the Federal Reserve more ability in the short run to respond flexibly to shocks that may hit the economy.

Inflation expectations in the United States are better anchored than they used to be but are still too volatile for optimum performance of the economy. Announcing an actual number or range would serve to anchor public expectations of inflation more firmly and avoid the risk of “inflation scares” that might unnecessarily raise nominal bond yields.

Third, from a communications viewpoint, financial markets would be well served by knowing the medium- to long-term inflation objective of the Fed. An explicit inflation objective would help market participants accurately price long-term assets, both by anchoring long-term inflation expectations and by giving the market better information about the likely path of short-term policy as the Fed moves toward its long-term target. And fourth and finally, I think an inflation target does introduce an additional measure of accountability for the Federal Reserve, although I would put that as least important of the things I've mentioned.

On the downside he hasn't worked on Wall Street, and it might take a while for the bankers and financiers to get comfortable with the academic.

Here's Bernanke's c.v. and Princeton home page. In August, John Tamny wrote a critical article on Bernanake for National Review. "For his views on money, Bernanke has the potential to be very dangerous," he writes." Brad DeLong countered. It will be fun watching dueling economists for a day or two.

"Bernanke's the Man"