Measured against his peers
We wrote in a piece about the New Boy that the markets were taking the measure of Ben Bernanke in the market meltdown of the last month. The WSJ now addresses this important subject:
When Ben Bernanke was nominated to head the Federal Reserve in 2005, he promised to “maintain continuity with the policies and policy strategies established during the Greenspan years.” But in handling his first financial crisis, Mr. Bernanke shows signs of a break with Alan Greenspan, the Fed’s chairman from 1987 to 2006. Ben Bernanke is showing a break with Greenspan’s practice of cutting rates during times of financial crisis. WSJ’s Greg Ip explains what it suggests about future Fed policy. That shift is important in understanding why Mr. Bernanke hasn’t cut the Fed’s main interest rate yet, and it could alter investors’ expectations of how the Bernanke Fed will function.
The Fed historically has had two major economic duties. Maintaining financial stability is one. Controlling inflation while preventing recession is the other. To Mr. Greenspan, market confidence and the economy’s growth prospects were so intertwined as to make the Fed’s two duties almost inseparable. He cut rates after the 1987 stock-market crash and the near-collapse of hedge fund Long-Term Capital Management in 1998 to prevent investor reluctance to take risks from undermining the nation’s economic growth.
By contrast, Mr. Bernanke distinguishes between the central bank’s two functions. So, on Aug. 17, the Fed cut the interest rate and lengthened the term on loans to banks from its little-used discount window in hopes banks would use the window — or at least the knowledge it was available — to lend to solid borrowers having trouble getting credit amidst the market turmoil. The action was aimed at restoring the normal functioning of disrupted credit markets, not primarily at boosting growth. The Fed, meanwhile, hasn’t cut the far more economically important federal-funds rate, charged on loans between banks, which is the benchmark for all short-term U.S. borrowing costs.
To be sure, all central bankers see a link between financial and economic stability. Falling prices for assets like stocks, bonds and homes and tighter credit conditions can damp spending and investment. But, “There’s no doubt they were trying to draw a distinction between using the main tool of monetary policy, which is the federal-funds rate, and aiming the discount rate at restoring the plumbing,” says Alan Blinder, a former Fed vice chairman.
To be sure, if Mr. Bernanke eventually cuts the federal-funds rate, as markets anticipate, the contrast with Mr. Greenspan will be less sharp.
Dealing effectively with market panics and discontinuities is a hallmark of successful Fed Chairmen. It remains to be seen whether Mr. Bernanke will rise to the task.