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Bernanke Put to Test as U.S. Economy Struggles

January 21, 2008 at 6:25 PM EDT
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Federal Reserve Chairman Ben Bernanke has called for government action to revive the slowing U.S. economy, in a key test of his tenure as the head of the central bank. Two business reporters consider how Bernanke is responding to the economic downturn and how his background has prepared him to be a key decision maker.

JIM LEHRER: Next, a look at how Federal Reserve Chairman Ben Bernanke is responding to the troubled economy. Ray Suarez has our story.

RAY SUAREZ: The steep drop in securities markets around the globe today reflected growing worry about the U.S. economy and the chances of a recession.

Across Europe, in Asia and South America, stock indices were down by multiple percentage points. Even with U.S. markets closed for the King holiday, Dow Jones futures were down more than 500 points.

While the Dow Jones itself may not drop when the market opens tomorrow, it and other indices have been falling steadily since the start of the year. The Dow is down almost 9 percent in January alone, after a string of bad signs.

The dollar’s value is dropping; inflation is up; job numbers are weak; and home values are falling, as the impact of the subprime lending crisis is slowly spreading.

It all adds up to the first major test for the Federal Reserve chief, Ben Bernanke, now two years into the job. At first, Bernanke said, he thought damage would be limited to the housing market, as he said in Chicago last May. “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

Since then, Bernanke has made several moves to spark the economy. He’s repeatedly lowered interest rates, and the Fed has injected more cash into the banking system to spur lending.

Then, on Capitol Hill last week, he gave his blessing to the idea of a stimulus package.

BEN BERNANKE, Federal Reserve Chairman: A fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so. Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving.

RAY SUAREZ: Wall Street will be watching for Bernanke’s latest moves next week, when the Federal Reserve board meets and is expected to lower interest rates again.

Finding new, creative approaches

RAY SUAREZ: For some insight into the evolution and education of Ben Bernanke as Fed chair, we turn to two journalists who've written extensively about him. Roger Lowenstein wrote this week's cover story in the New York Times Magazine, and Greg Ip covers the Fed for the Wall Street Journal. He recently wrote an extensive story about Bernanke, as well.

Roger Lowenstein, in about two years on the job, has Ben Bernanke had to modify positions he's previously espoused or change the way he views the work of the Fed chair?

ROGER LOWENSTEIN, New York Times Magazine: No, I don't think so. You know, this is a guy who studied the Fed, Ray, for 30 years or so.

What he's discovering is, you know, it's a lot different to study it than to be in the middle of it and running it in the midst of a crisis. And, you know, he's dealing with that. It's the same playbook, but now he's got to put it in action.

RAY SUAREZ: Has the "putting it in action" part, Greg Ip, taken him to places where, during his confirmation hearings, you might not have expected him to go?

GREG IP, Wall Street Journal: Well, I think it really has, Ray. I mean, when he was thinking about the job he was going to be doing, he primarily thought in terms of keeping inflation low and keeping the economy out of recession.

And when you're operating in that kind of a mode, you can sort of look ahead by a year or two, try and set the interest rate right. And if you get it wrong, six weeks later you get a chance to do it again.

You're now in crisis mode, where essentially the outlook can change radically in the space of 24 hours. And the policy that looked right on Monday looks completely wrong on a Tuesday. He's had to be much more nimble and much more creative.

Just to give you one example, on a couple of occasions, rather than turning to their main instrument, which is the short-term interest rate, to try and re-liquify the markets, he's tried to do something creative with the discount window, which is basically this very ancient tool the Fed used long ago to try and get money to the banks.

And he's tried to find different ways to get the markets working using that old tool.

Contrasts with Greenspan

RAY SUAREZ: Roger Lowenstein, in that time, have we seen any differences between Ben Bernanke and his longtime predecessor, Alan Greenspan?

ROGER LOWENSTEIN: Well, the biggest difference I think between Bernanke and Greenspan is Greenspan really ran the Fed like the czar, if you will. He was the guru for all of us. And I think Americans tended to think of him as the guy who ran the whole economy, almost, not just the Fed.

Bernanke is very much a consensus guy. And people may not realize it, but interest rates aren't really determined by the Fed chairman. They're determined by a committee. And Bernanke is one, but he only has one vote.

And as one former committee member remarked, he's really put the C back in the FOMC in that committee. And so the decisions, they're talked out; they're discussed.

At the end of the day, the committee gets basically where he wants, but it really is much more government by committee now.

RAY SUAREZ: Greg, apart from that more collaborative style that Roger just cited, is there a difference in approach, in the way he talks about the economy, the way he shows the Fed's face to the public?

GREG IP: Oh, very much so, Ray. For example, Greenspan was famous for giving these opaque speeches where there would be a little clue planted about what he planned to do with interest rates next.

And Bernanke dislikes that approach. And instead, he has tried to give speeches that are quite clear about where he sees the economy going and where the risks are, but are relatively bereft of any explicit clues about interest rates.

Moreover, he's a big believer in giving out clear forecasts and telling the public what the Fed's objectives are, two things that Greenspan did not like to do.

So in October, the Federal Reserve began releasing a new set of quarterly forecasts with fairly detailed projections about where the Federal Open Market Committee expects things to go. I think that the challenge they're meeting now is that that forecast is changing radically week by week.

Moreover, that, in a time like this, you can have 17 or 19, as it is, Federal Open Market Committee members with differing points of view, all quite legitimate because there are conflicting risks on growth and inflation.

But if they're all going out and publicly stating what their own preferred policy is, it can seem incoherent. And Bernanke, notwithstanding his personal belief that democratic policymaking is better, has had to sort of speak more loudly, more frequently to try and assert a central voice for the Fed.

Coping with two economic threats

RAY SUAREZ: Well, in what Greg Ip just described, Roger, is there also a risk of occasionally getting burned, of having people read too much into what you've had to say?

ROGER LOWENSTEIN: Yes, there's certainly a risk of being burned. If you're the Fed chief, you're going to make some wrong moves.

But I think the risk for him is less ultimately in how he's communicating or whether it's a committee or one guy than the fact that his whole career he really studied two types of dangers.

One was similar to the Great Depression, when the economy would slow down and would lose the mechanism to start up again. And the other was a sort of opposite terror, the 1970s, the great inflation.

And now he's suddenly having to deal with at least the prospect of both. And the medicine for each is different. In fact, it's contrary. And, you know, when you cut through the differences in style, between him and Greenspan, that's the rub he's facing.

RAY SUAREZ: So given his history, given his academic work, given what he has told the public all along, which of these enemies to the economy is he going to see as the more important one? And which one is he going to use the tools of the Fed to go after first? Is it inflation?

ROGER LOWENSTEIN: Right now, clearly the threat to the economy, the threat to the economy will slow down, is the greater risk. That's certainly the greater short-term risk. I suppose economists now say there's a 50 percent chance we're already in a recession.

But if you look out in the future -- and I'm sure Bernanke is -- there couldn't be a worse thing to say about a Fed chairman than that he allowed the inflation genie to come back out of the bottle. So it's not like he can just worry about one. He's really always got to be worrying about both.

GREG IP: I think Roger has got it exactly right. People accuse Bernanke and the federal role of having sent conflicting messages and not having been forceful enough at addressing the recession risk for the last four or five months.

And I think the reason for that is because they honestly believe that there are more than just risks on the growth side. There are risks on the inflation side.

Now, in the last few weeks, we have clearly seen a shift where they are now far more focused on the risks to the economy. I think you will see the Fed cut interest rates at least half a percentage point at their meeting next week, possibly more.

You'll probably see strong signals that they're prepared to do even more than that to keep the economy out of recession.

But to Roger's point that no chairman wants to be remembered as the chairman that allowed inflation to rise, I think at the back of their mind is they're keeping open the possibility that, once the crisis passes, they will take those rate cuts back.

Assessing the role of the Fed

RAY SUAREZ: Now, he has publicly said that it's not the job of the Fed chairman to prick bubbles that are building inside the economy. Has the reality of being in that chairman's seat perhaps made him see that in a slightly different way?

GREG IP: Possibly. Now, there's a lot of people going around saying, you know, Bernanke has basically just inherited the mess that Greenspan made. Now, leaving aside whether or not Greenspan made a mess, Bernanke was on the Board of Governors while the chairman, while Alan Greenspan was running that policy. And Bernanke was very supportive of it.

I doubt that he has changed fundamentally his point of view that there is not much the Fed can do about acid bubbles. I think that what he may be rethinking is the notion that you can also at the same time have a hands-off approach to the regulation of the financial markets.

The Fed does not just set interest rates. It is also the most powerful financial regulator in the country. And the Fed was running a very easy monetary policy at the same time that there was a proliferation of new types of mortgages, and credit instruments, and derivatives, and expansion of the banking sector into new types of industries.

And that was met with a relatively light touch by the Fed and other regulators. And there might be a rethink going on at the Federal Reserve and at all levels of policymaking that that might have been the wrong approach.

In other words, perhaps you can't do much about the acid bubble itself, but you can certainly mitigate the consequences when that bubble bursts.

RAY SUAREZ: So among the constituency that we might call the financial industry, Roger, what kind of job do they think Ben Bernanke is doing?

ROGER LOWENSTEIN: You know, I think it's too early to say right now. I know I'm ducking you, but -- we're sort of mid-crisis. He's presumably still cutting rates. I think Greg is right. He's going to cut next week.

We're looking down the road to maybe a recession, maybe not. And a year from now, two years from now, people will start to evaluate him.

This episode could be in textbooks. I think you can say he's handled it so far as well as virtually anybody would have, any new person, certainly. We'll see.

RAY SUAREZ: Roger Lowenstein, Greg Ip, gentlemen, thank you both.

GREG IP: Thank you, Ray.