Stephen King: Forget the Greenspan model, Bernanke's first challenge is to become boring Ben

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The Independent Online

Some people have argued that Mr Bernanke is too relaxed about inflation. After all, they say, Mr Bernanke was the architect of the Federal Reserve's aggressive rate cuts after the dramatic fall in stock prices in 2000 and 2001 and, by winning that debate, Mr Bernanke simply added fuel to the inflationary fire that now threatens to engulf us. On this interpretation, the Federal Reserve is in danger of losing much of the anti-inflationary credibility that was established during Paul Volcker's stewardship of American monetary policy in the early 1980s.

Others have argued that Mr Bernanke, supposedly a devout inflation targeter, will shift towards a much more hawkish anti-inflation stance when he takes over at the beginning of February. This view depends on the idea that Mr Bernanke has a symmetrical hatred of threats to price stability: if inflation is too low, and threatens the onset of deflation, he's more than happy to slash interest rates but, equally, if inflation is too high and threatens to accelerate, he's prepared to jack interest rates up to painfully high levels.

Still others have suggested that, irrespective of his views, the real problem is likely to be Mr Bernanke's lack of experience as a public administrator. Faced with external shocks - higher oil prices, terrorist attacks, hedge fund disasters, whatever else your fecund imaginations are capable of conjuring up - he simply will be unable to reach a coherent view, swayed too much by the vagaries of academic discourse and offering insufficiently steely leadership.

Mr Bernanke is not a stupid man. Far from it, he is one of the leading monetary economists of his generation. And, because he understands a lot about what makes a central bank credible, I doubt that any of the three caricatures outlined above is likely to prove particularly accurate.

Just before Mr Bernanke finished his first stint at the Federal Reserve earlier this year, he was happy to admit that, as a former academic, he still had a lot to learn: "I always thought that I would be an academic lifer ... The sum of my political experience consisted of two terms on the local school board ... I served seven years as the chair of the Princeton economics department, where I had responsibility for major policy decisions such as whether to serve bagels or doughnuts at the department coffee hour." But admission of inexperience is, in my view, a good thing: far better to admit one's weaknesses and do something to address them than to pretend that those weaknesses never existed in the first place.

Mr Bernanke is also happy to admit that there will, initially, be problems with public perception. In remarks to a conference on "Reflections on Monetary policy after October 1979", Mr Bernanke noted that "the policy preferences of a newly appointed central banker will not be precisely known by the public but must be inferred from policy actions ... Knowing that the public must make such inferences might tempt a central banker to misrepresent the state of the economy ... for example, the central banker may feel compelled to tighten monetary policy more aggressively than is warranted in order to convince the public of his determination to fight inflation."

For these reasons, and more, Mr Bernanke is a great believer in what he describes as an "explicit, well-designed, and transparent framework for monetary policy, one which sets forth the objectives of policy and holds central bankers accountable for reaching those objectives (or, at least, for providing a detailed and plausible explanation of why the objectives were missed)". A good example of this approach is the arrangements that currently exist at the Bank of England. The Bank has an inflation target, it publishes a quarterly Inflation Report, the public understand, at least intuitively, what the Bank is aiming to do, and the Bank is under obligation to write an letter of explanation to the Chancellor of the Exchequer should actual inflation stray too far from the target.

Mr Bernanke has suggested that inflation should, ideally, lie within " what I think of as the "comfort zone" of 1 to 2 per cent". If so, the chart shows that, at the moment, Mr Bernanke might be suffering from what Sir Alex Ferguson would describe as "squeaky-bum time". Core inflation in the US is right at the top of this range, suggesting that earlier fears of deflation may, indeed, have been replaced by significant fears of excessive inflation.

But it would naïve to suggest that Mr Bernanke is about to subject the American economy to a sudden dose of monetary cold turkey. In his eyes, central bankers should, for the most part, pursue a policy of gradualism, fully aware that the road ahead is uncertain. Moreover, Mr Bernanke has little time for those who think that there is some clearly-defined neutral interest rate that the Fed is constantly striving to reach: "It is not helpful, in my view, to imagine the existence of some fixed target for the funds rate toward which policy should inexorably march ... the fact that far future short-term interest rates have recently declined [in other words, that long-term interest rates have been lower than the Fed expected] ... suggests that the neutral funds rate may be somewhat lower today than it was in the past."

That some people have tried to portray Mr Bernanke as a dangerous maverick is a reflection of their own misunderstanding of the monetary policy process, not a sign of Mr Bernanke's lack of qualifications. If there is a maverick at the Federal Reserve - albeit a mostly benign one - he's quite a lot older than Mr Bernanke and planning to retire at the end of January. Alan Greenspan has, in many ways, been the antithesis of a modern central banker: a man with his finger constantly on the economic pulse, changing his mind on policy in line with the latest set of economic risks, with less reliance than most on a formalised decision-making process.

Despite Mr Greenspan's colossal reputation, I have my doubts that his approach will survive his departure: by giving the impression that all risks can be contained through his own wizardry, Mr Greenspan may have encouraged excessive risk-taking, most obviously with the equity bubble in the late 1990s and, more recently, with the emergence of a housing bubble.

Mr Bernanke knows full well that the markets have placed Greenspan on a pedestal which is necessarily out of reach for mere central banking mortals. Perhaps Mr Bernanke will, in time, scale the same heights. For the time being, though, Mr Bernanke will rely on the strength of the Federal Reserve as an institution, rather than on Greenspan-style demagoguery. He will almost certainly encourage a collective effort from Fed members, governors and others, to get a consistent and transparent message across to the markets. "Monetary policy works largely through indirect channels - in particular, by influencing private-sector expectations and thus long-term interest rates ... failing to communicate with the public does not create genuine policy flexibility but only reduces the potency and predictability of the effects of given policy actions." Of, course, this approach may eventually make monetary policy rather dull but, in the words of Mervyn King, Mr Bernanke's former academic colleague, "our belief is that boring is best".

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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