Gideon's Blog

In direct contravention of my wife's explicit instructions, herewith I inaugurate my first blog. Long may it prosper.

For some reason, I think I have something to say to you. You think you have something to say to me? Email me at: gideonsblogger -at- yahoo -dot- com

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Monday, October 24, 2005
So it's Bernanke. Funny, 'cause he doesn't look like much of a gym rat. But he does work right down the hall, so he had that going for him.

Actually, I think this is a good call. Bernanke is a sober, smart centrist. He doesn't think the Fed should focus on asset price levels ("pricking" bubbles) nor should it aggressively stick its nose into fiscal matters properly left to the legislature (though it should obviously let people know when fiscal imbalances are forcing hte Fed to shift its own posture). He thinks the Fed should stick to its knitting: promoting price stability.

What Bernanke is known for in terms of how the Fed should behave differently than it does is in terms of greater transparency. If the Fed is targeting a particular level of inflation (which it arguably already does, though not formally) it should announce what that level is. If the Fed is considering hiking or cutting rates, it should signal that. It should not, in other words, engage in the kind of oracular communication that has been the Greenspan style. I'm inclined to think Bernanke is right that increased transparency is good.

The other thing he's known for is for saying that "price stability" should be understood to mean a stable and very low - but positive - rate of inflation. This is, de facto, how the Fed understands price stability right now, but the idea of actually saying explicitly that a low rate of inflation is *optimal* - as opposed to, say, a zero rate of inflation or a low rate of deflation - has got some people in a lather.

It shouldn't. There are three reasons why people worry about Bernanke's view. First, there's the fear that low inflation can always become accelerating inflation. But low deflation can always become a depression; that's why we have monetary policy and not a completely self-regulated economy. Why is the one risk so much more to be feared than the other? More to the point, we now have 20 years of evidence that a vigilant Fed can keep inflation in check without pegging the currency to some commodity whose supply cannot be controlled by fiat.

Second, there are those who simply disagree about what the "optimal" level of inflation is - slightly positive, zero, or slightly negative (no one thinks high inflation or severe deflation is in any way good). The evidence on this question is mixed. What is clear, though, is that it the Fed has a lot more tools to try to keep inflation between, say, zero and two percent than between zero and negative two percent; put simply: the Fed can always quite easily contract the money supply if inflation heats up to much, but cannot so easily expand it if deflation accelerates and nominal rates are already zero. This is reason enough to be biased in favor of a small positive inflation rate.

Finally, there are those who correctly identify inflation as a kind of tax, redistributing wealth from owners to debtors. This is true, but it's also one of the safety valves of our political system. Every political system needs these kinds of safety valves, and a very low, positive rate of inflation is a pretty cheap and painless safety valve.

The most important reason why I think Bernanke is a good pick: he's got decent political skills (so they say) and the Fed Chairman is a political position. You want an excellent economist, yes, but you also want someone who can build consensus and make the markets feel confident in monetary policy. A stridently ideological or personally prickly individual is not going to be as good at achieving those objectives, even if that individual was somewhat more often right.

Like Chief Justice Roberts, Bernanke is going to disappoint some true believers. I happen to think that, mostly, Bernanke is right and the true believers wrong about the issues on which they disagree (certainly on the question of whether it would be a good idea to return to the gold standard). And anyone who thinks rates should not have been rising in 1999, or should not be rising now, is living on some other planet than the one I'm most familiar with. But regardless, these kinds of critics (who we will be hearing from) should remember that Bernanke is going to the Fed, not the Treasury, and the Treasury is where decisions about taxes are made, along with Congress.

I do think Bernanke should be asked at hearings what kinds of indicators he will use to predict the future price level (he must have some, or he'll be too backward-looking to make monetary policy effectively) and how his approach in this regard would differ from Greenspan's, if at all. But I don't expect to be alarmed by his answers.

This is a good pick. I wish I had some basis for thinking it was part of a pattern.