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Tuesday, 16th September 2025 |
| The Bernanke Fed - the challenge of protecting the Greenspan legacy |
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| John Coffey and Richard Iley assess how Ben Bernanke, Alan Greenspan’s successor as chairman of the US Federal Reserve, will control the US economy, once he steps into ‘the most successful central banker in history’s’ shoes on March 28th. |
Fed Chairman designate, Ben Bernanke, takes over from Alan Greenspan in February and will chair his first FOMC ( Federal Reserve Open Market Committee) meeting on March 28th. Given that Greenspan is arguably the most successful central banker in history, having presided over the longest economic expansion in modern times, this is a somewhat daunting task. Fed watchers have been asessing Bernanke's track record & his recent statements in order to interpret how the transition to his leadership will impact Fed policy, and consequently the global locomotive that is the U.S economy.
Some people have asked if Bernanke will change the way the Fed operates: he already has. It was Bernanke who suggested the forward looking language that enabled the Fed to so effectively manage the substantial rise in interest rates without market disruption.Bernanke was also the architect of the previous' deflation avoidance' strategy which ensured that the U.S would not risk a ‘Japanese style ' deflation. The more recent addittion of a second year to the forecast provided in the Fed chairmans ‘Humphrey Hawkins' testimony (bringing published Fed forecasts into line with the two year horizon most infaltion targeters publish) was also a Bernanke suggestion.
In his prepared remarks to the Senate, Bernanke sprung few surprises in stressing his determination to preserve the ‘independence and non-partisan’ status of the Federal Reserve and his intention to ensure continuity. Bernanke choose to emphasise that that ‘the Federal Reserve's success in reducing and stabilizing inflation and inflation expectations is a major reason for this improved economic performance. If I am confirmed, I am confident that my colleagues on the Federal Open Market Committee (FOMC) and I will maintain the focus on long-term price stability as monetary policy's greatest contribution to general economic prosperity and maximum employment.’ Translation: inflation is always any prudent central banker’s number one concern and I am no different. Those commentators who have crudely characterised me as a ‘dove’ are mistaken.
Even more significantly Bernanke used this opportunity to nail his well-documented inflation targeting colours to the mast, in effect meeting speculation that he might push the Fed in this direction head on. He emphasised that:
‘one possible step toward greater transparency would be for the FOMC to state explicitly the numerical inflation rate or range of inflation rates it considers to be consistent with the goal of long-term price stability, a practice currently employed by many of the world's central banks. I have supported this idea in my academic writings and in speeches as a Board member. Providing quantitative guidance about the meaning of ‘long-term price stability' could have several advantages, including further reducing public uncertainty about monetary policy and anchoring long-term inflation expectations even more effectively’.
What Bernanke was arguing for today was set out in detail in an article in the Federal Reserve Bank of St.Louis Review last year ‘Inflation Targeting’, Ben.S. Bernanke, Federal Reserve Bank of St. Louis Review, July/August 2004, 86(4). In this article, as today, Bernanke argued for the value of first quantifying and then publicising the Fed’s optimal long-run inflation rate (OLIR). It is important to emphasise, as Bernanke did in the article, that the announcement of an OLIR (probably 2 per cent on the National Accounts measure of consumer price inflation) is a very different beast to the more formal inflation targeting as practised by say the Bank of England or the ECB.
Neither the horizon at which the inflation objective is to be attained (for example, 2 years in the Bank of England’s case) nor the expected path of output and inflation would be specified. In the academic jargon, Bernanke’s proposal would be aimed at getting the mean of inflation right while leaving the determination of the variance open for discussion and debate in the future. As a result, Bernanke can rightly say that the announcement of an OLIR would be unlikely to limit the jealously guarded flexibility of the Fed in framing monetary policy.
So why bother? A number of important reasons come to mind:
• Recent academic research has emphasised the importance of central banks providing a point estimate of desired inflation in more concretely anchoring private-sector expectations. Mr.Bernanke is well aware of the importance of maintaining low and stable inflation expectations if his tenure as Fed Chairman is to be a success.
• All central banks informally target inflation any way. As we have been emphasising, by revealed preference the Greenspan Fed has de facto targeted CPI inflation at 21⁄2 per cent. Why not acknowledge de jure, what is practised de facto, likely making the job easier?
• The announcement of an OLIR would constitute an important, incremental step towards an more formal inflation targeting regime if Mr.Bernanke were able to build a consensus for further institutional change.
The other notable element of Bernanke’s testimony was his praise of Chairman Greenspan’s ‘risk management’ approach to monetary policy. But is this not at odds with his concurrent championing of moving towards a possible inflation targeting regime?
Not necessarily. As Mr. Bernanke has previously emphasised in another important speech, the risk management approach of Greenspan is itself very clearly a forecast-based policy ‘The Logic Of Monetary Policy’, Ben. S. Bernanke, Remarks to the National Economists Club, Washington DC, December 2, 2004. Via a combination of models and expert judgement, forecasts are made of not only the most likely scenarios for the economy but also a range of lower-probability outcomes. All are taken into account. In effect, the whole probability distribution of outcomes, not just the average or most likely outcome matters to policy makers. And that Bernanke whole-heartedly endorses this approach was shown by his behaviour in 2003 when he was in the vanguard of insuring that the small, but alarming, risk of a pernicious deflation was successfully excised.
So how does this emphasis on monetary policy risk-management dovetail with a penchant for inflation targeting? Easily is the answer. Best practice in inflation targeting is increasingly not only for central banks to adjust policy rates to ensure that their inflation forecast at some sensible horizon hits the desired target (in the jargon, the inflation forecast becomes the intermediate policy target) but also that increasing attention is paid to the probability distribution around the central or modal tendency of that forecast. This is more familiar than it sounds because, one again, the Fed is in many respects already following many of these precepts in a de facto manner. Twice a year, it presents forecasts for the core PCE deflator with a range around the central tendency. At the moment, the forecast range is skewed to the upside. In effect, therefore, the Fed’s mean forecast for inflation is above its modal projection ensuring that it retains a bias to hike policy rates to counter this ‘upside risks’ for the foreseeable future.
Bernanke’s decision to push the possibility of a move towards formal inflation targeting to the front of agenda, suggests that his stewardship is likely to characterised by a restlessness to see many of the Fed’s current informal practices formalised in line with current central banking best practice. The announcement of an OLIR as advocated yesterday would likely be the first baby step not the end point of his desired institutional reform. It does not stretch the imagination to envisage the Bernanke Fed eventually moving to an inflation-forecast targeting regime with particular weight attached the probability distribution around the central forecast projection. |
John Coffey is head of treasury at BNP Paribas, Dublin, and Richard Iley is senior economist, North America, BNP Paribas
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