The Hindu Business Line : New Fed Chairman from February

To succeed the US Fed Chairman, Mr Alan Greenspan, is a challenge, especially when the successor is a comparatively unknown, albeit brilliant, economist. Mr Ben Bernanke has a daunting task ahead of him considering that the Fed is today less in command of its economic circumstances than before. But, judging by his stand in his speeches and writings, he may well surprise the world by an innovative and unconventional approach to global economic problems, says S. Venkitaramanan.

MR BEN Bernanke, the Chairman of President Bush's Council of Economic Advisers and a former Professor at Princeton University, is to succeed Mr Alan Greenspan as Chairman of the US Federal Reserve. People have been quite exercised about the successor to Mr Greenspan, who occupied the top slot at the Fed for 18 years with great success and aplomb.

To succeed Mr Greenspan is a challenge, especially when the successor is a comparatively unknown, albeit brilliant, economist. True, Mr Bernanke has had a stint at the Federal Reserve as a colleague of Mr Greenspan's from 2002 to early 2005, where he had a chance to participate in the latter's consensual policy-making. Significantly, his choice has been welcomed by many, including Milton Friedman.

Mr Bernanke has a daunting task ahead of him considering that the Fed is today less in command of its economic circumstances than before. Domestic savers have less to do with US bond prices than foreign central banks, in view of the huge dependence of the US economy on foreign capital flows.

The credibility of the Fed is of extreme importance, especially in this context, with some foreign investors inclined to turn sensitive to the dollar's strength and the health of the US economy.

Further, to succeed such a great central banker as Mr Greenspan is itself a challenge. Be this as it may, the rich legacy of Mr Greenspan, his legendary successes in taming inflation and nurturing growth in the face of the dotcom and the LTCM crashes, have themselves created a difficult precedent for the Chairman-designate to follow. This challenge is also complicated by Mr Bernanke's known position on what he calls "inflation targeting" as the guiding tool-kit of the central bank in preference to the more discretion-based stance of Mr Greenspan and his predecessor, Mr Paul Volcker. Mr Bernanke himself admits that his recommendation is one of constrained discretion.

By now, most observers of the monetary policy scene are familiar with monetary targeting and exchange rate targeting. In contrast to these conventional paradigms, inflation targeting or, rather, inflation forecast targeting, as the IMF's World Economic Outlook calls it, has a clearer focus on inflation. It gets to the core of the concerns that face a central bank, especially in these days of rising inflationary expectations.

Mr Bernanke has himself been pressing for "inflation targeting" as a policy for the Federal Reserve itself, but Chairman Greenspan has, in effect, overruled him because he considers that inflation targeting may be too restrictive and does not provide necessary degrees of freedom.

Bernanke himself admits that inflation targeting amounts to constraints on the central bank as it means the central bank will focus more directly on inflation numbers.

But he has necessarily to make his compromises, especially in his forthcoming hearings before the Congress for his confirmation.

Growth of the economy and increase of jobs are both high on the policy agenda of the political masters in Washington DC. The Fed itself is mandated to ensure adequacy of employment. Mr Bernanke is not unaware of this and he will naturally adjust his focus on fighting inflation to keep in mind the twin goals of growth and job expansion. Does Mr Bernanke's coming in at the Fed spell a change in interest rate tightening? He himself had been a party to many of Mr Greenspan's 25-basis-point increases when he was at the Fed. At the same time, his flexibility is seen from the fact that he is on record as having endorsed in a well-publicised speech the policy of reducing interest rates when the Fed sensed the threat of deflation in the US economy.

He, in fact, joined Mr Greenspan in bringing down the funds rate to the level of 1 per cent, below which there was really no further room to squeeze the interest rate.

In a widely-noticed speech given at the time, Mr Bernanke declared himself not averse to opening the printing press if deflation was the danger and the nation's economic growth was at risk. The "Bernanke effect" on the global economic scenario will depend most critically on how clearly and quickly he adjusts the interest rate in the first few months after he takes over in February 2006. His credibility will then be on test.

The markets have, however, declared that, in their judgment, he would be prone to raising interest rates. Bond prices on Wall Street had fallen on the news of his nomination. But expectations on the Wall Street bond market may be deceptive, as was proved in Mr Greenspan's case.

The markets had "greeted" the announcement of Mr Greenspan's appointment in the 1980s with a similar but less sharp fall in bond prices. In spite of this, Mr Greenspan deservedly became a darling of the markets over time, notwithstanding his tendency to lecture them about irrational exuberance.

Who knows whether the markets and the world may come to like the brilliant Ben Bernanke in spite of, or perhaps because of, a declared failing for Hawaian shirts and an "unsuited" dress code in the Fed?

Maybe he will evolve a more suitable policy code for all central bankers in his own time. The test of a central banker comes when a crisis of confidence hits the markets and the economy. He has then to think out of the box. Textbook solutions are not sufficient. They may even be counter-productive.

In this sense, Mr Greenspan has proved a great manager of crisis. As soon as he was anointed Chairman, he had to face the great market crash in 1987. His response was classic. He flooded the market with liquidity and calmed it. Similarly, he took on the crisis associated with the human collapse and the Asian crisis with aplomb.

He never panicked. He carried the markets and the rest of the world with him. In the 1990s, Fed experts argued that there was a great danger of inflation and that Mr Greenspan had to decide whether he was to tighten the screws or loosen them.

His instinct told him that the technological revolution, including IT, was really working to increase US productivity.

He gambled in favour of technology-led growth and kept rates benign. This led to the surprising growth of the 1990s. A simple inflation target would not have helped in the crisis.

The question is whether Mr Bernanke will be equally flexible and innovative when confronted with crises. I feel that a challenge of the kind Mr Greenspan faced will bring forth a similar bold response, if not a more flamboyant one from Mr Bernanke, who has spent years of academic research on such issues.

A well-prepared mind such as his is the best guarantee that it can acquit itself brilliantly when a crisis unfolds unexpectedly. There are many candidates for potential economic crises facing Mr Bernanke. One possibility is that of Asian central banks losing their nerve and moving their reserves away from the greenback. A consequential potential risk of a falling dollar is a development that is in the nature of an accident waiting to happen.

If Mr Bernanke is to be judged by the exposition of his stand in his speeches and writings, he will be more than equal to any such challenge that a global decline of the dollar can bring.

True, Mr Bernanke has to win the acceptance of his approach and build confidence with the markets, particularly among his fellow central bankers, especially from Asia. But that should not be difficult considering that the Asian central banks have not much of an alternative avenue for their surpluses.

That, by itself, is Mr Bernanke's best bet. It is, after all, the privilege of the world's richest nations to issue IOUs which carry credibility, however low its own net worth may be. The Bernanke effect on the world's imbalances may well be to find an alternative way of investing these reserves, maybe in a replay of the Brettonwoods twins — a reinvigorated IMF and a rejuvenated World Bank.

Bernanke may be as different from Greenspan, as Greenspan was from Volcker. He may very well surprise the world by an innovative and unconventional approach to global economic problems.

In this, his academic work will definitely give him plenty of precedents and paradigms to build on, although some of his recent speeches on global imbalance do not give much evidence of such innovative thinking.

In the same way, as Greenspan proved innovative for the US domestic economy, may we hope that Bernanke will turn out to be revolutionary on the subject of resolution of global economic imbalances? All this, of course, is subject to a big caveat.

The President, Mr George W. Bush, must be willing to listen to his former Chairman of the Council of Economic Advisers even though he has changed his place of work to the exalted office of the Federal Reserve Building. Here is wishing Mr Bernanke a successful term as the head of the Fed, one that matches the glorious `reign' of his legendary predecessor.

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