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Bernanke gets good marks in freshman year

As he wraps up his first year on the job, Federal Reserve Chairman Ben Bernanke has generally gotten good marks.  But he remains untested in the kind of financial crises that gave his predecessor, Alan Greenspan, the power to send investors scrambling with the turn of a well-crafted phrase. By's John W. Schoen
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Federal Reserve Chairman Ben Bernanke concluded a two-day meeting of the nation’s central bankers Wednesday, wrapping up a freshman year in which he has gotten generally high marks for bringing the economy in for a "soft landing."

But the former Princeton University professor still has his work cut out for him in improving the Fed’s communications with the outside world, and area where he has tried to provide more clarity than his sometimes inscrutable predecessor, Alan Greenspan.

Bernanke has won mostly praise from Congress, the financial markets and the public. Both unemployment and inflation are at low levels and, despite the unraveling of the housing boom, the U.S. economy seems to be on track to avoid recession with slower but steady growth.

Under his leadership, the central bank is also working to give investors better insight into its deliberations and decision making, hoping to peel back the shroud that has historically obscured the sometimes mysterious workings of the powerful body.

That effort is expected to be a key focus of the latest meeting of the Federal Open Market Committee. Fed policy-makers left rates unchanged for the fifth straight meeting Wednesday.

But Bernanke remains untested in the kind of financial crises that gave Greenspan, the power to send investors scrambling with the turn of a well-crafted phrase.

By any measure, the current chairman had a hard act to follow. Greenspan’s 18-year rein was one of the longest, and arguably the most visible, in the Fed’s 92-year history. As Bernanke himself put it in his Senate nomination hearings in November 2005: “One may aspire to succeed Chairman Greenspan, but it will not be possible to replace him."

Under the Bernanke Fed, the decision-making process on interest rates has reportedly come to rely more heavily on the rest of the board, a change in culture made easier by recent heavy turnover: In addition to Bernanke, three of the five remaining members of the board are also freshmen.

At official Fed meetings, in a departure from the traditional protocol of speaking strictly in turn, Bernanke reportedly has encouraged a more open discussion format. Between meetings, board members have been more vocal in public comments, in contrast Greenspan’s solo performance as the face and voice of the Fed.

But Bernanke’s solo performance has yet to be tested in a financial crisis, when the markets won’t wait for a committee's deliberation and group pronouncement. By contrast, Greenspan’s performance was tested shortly after he stepped into the job.

Just two months after taking the oath of office as chairman, the stock market crash of 1987 presented him with one of worst financial crises since the Great Depression. Thanks in part to a series of hasty phone calls, and assurances that the Fed stood ready to flood the financial system with money to stave off a wider collapse, the stock market posted one of it biggest one-day rallies in its history the next day.

In more recent years Greenspan’s quick responses helped calm the financial markets following the Asian currency crisis in 1998 and the rescue of a $3.5 billion hedge fund, Long Term Capital Management, whose failure he later told Congress could have brought wider damage to the economy. 

But while Bernanke may be less conspicuous and enjoy lower name recognition than his predecessor, he has been much more transparent than communicating the Fed’s thinking to the public. For example, Greenspan was more inclined to talk about, say, the risk of inflation without even using the word itself. Here’s the former Fed chairman in front of a House committee in February 1994.

“Markets appear to be concerned that a strengthening economy is sowing the seeds of an acceleration of prices later this year by rapidly eliminating the remaining slack in resource utilization,” he said.

By contrast, Bernanke is much more plainspoken:

“Inflation has been higher than we had anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities,” he told Congress last July.

The new chairman has gone so far as to propose that the Fed set specific inflation targets, leaving little doubt among members of Congress and the public about where it stands. Formalizing a range of “acceptable” inflation, the thinking goes, would clearly signal whether the Fed was in the mood to get tough by raising interest rates or ease off with lower rates to get the economy moving faster. (Opponents of the move argue that it could needlessly tie the Fed’s hands in setting rates.)

The new policy toward more “openness” has been generally well-received, but Bernanke learned the hard way in his first year about the risks of too much transparency. After telling Congress last April that a steady series of rate hikes would end “at some point in the future” the stock market rallied on hopes that the Fed was ready to stop raising the cost of money. CNBC then reported Bernanke’s comments to a reporter that the markets had misunderstood his remarks. The market promptly retreated.

In June, the Fed chairman gave a speech about the dangers of rising inflation, sending the stock market into a steep sell-off. A few days later, stocks bounced back after Bernanke said that although food and energy prices had brought an uptick in prices, inflation expectations seemed to remain within historical ranges.

"It's very easy for academics to call for more transparency or to call for some particular regime like inflation targeting," said Jeffrey Frankel, a Harvard University professor who served on the White House Council of Economic Advisers under former President Bill Clinton. "When it's you (in charge), things look different.”

Bernanke has also been slower to take sides in the debate over government economic policies. Though the Federal Reserve had historically kept its distance from politics, Greenspan entered the fray as tenure progressed — most recently in support of the Bush administration’s tax cuts, an issue on which Bernanke has maintained neutrality.

But Bernanke has not been shy about warning Congress that the ongoing federal budget deficits — and the pile of debt they are leaving behind — can’t be ignored without serious consequences down the road.

“Official projections suggest that the unified budget deficit may stabilize or moderate further over the next few years,” Bernanke told the Senate Budget Committee last week.

“Unfortunately, we are experiencing what seems likely to be the calm before the storm," he said. "In particular, spending on entitlement programs will begin to climb quickly during the next decade. … These rising entitlement obligations will put enormous pressure on the federal budget in coming years.”