5 lessons Bernanke has learned on the job
WASHINGTON (MarketWatch) -- Back in 2006 when Ben Bernanke was named chairman of the Federal Reserve, he knew he'd make some mistakes, but he was pretty sure the Fed wouldn't do what the United States did in the 1930s or what Japan did in the 1990s that allowed depressed conditions to persist for years.
Monetary policy had learned from those errors, Professor Bernanke used to teach his students. A depression, great or otherwise, could never happen again.
In 2002, Bernanke gave a now-famous speech in which he asserted that he was "confident that the Fed would take whatever means necessary to prevent significant deflation in the United States." Furthermore, he asserted that "a determined government can always generate higher spending."
It was simply a matter of looking in the toolbox to find the appropriate policy. And if the toolbox didn't include just the right policy, the Fed could -- like the astronauts on Apollo 13 -- jury rig a solution.
A decade later, the U.S. economy is wallowing in a slow-growth recession, with high unemployment and stagnant or falling living standards. By now, Bernanke has learned a few things about the practical side of economic policy making.
Here are five lessons Bernanke has learned – or should have learned.
1) Politics matters as much as policy does. Bernanke may be certain that the Fed could stimulate spending in the economy and pull us out of our depression if it applied enough force, but Bernanke doesn't act alone. He's only one vote on a 12-member committee that decides monetary policy.
What's more, the Fed doesn't act in isolation. Right now, we don't have a "determined government." Various arms of government are pulling in different directions. Monetary policy is stimulating spending at the same time that fiscal policy is holding it back. Bernanke has been pleading with Congress to give him a little help, to no avail. Regulatory policies designed to strengthen banks may be standing in the way as well, by stretching out the deleveraging process or by making credit less available.
2) Bluffing doesn't work. Monetary policy can be more effective if the right words are spoken. But those words have to be backed up with action, if necessary. Promising to keep interest rates low for an extended period can help to lower longer-term interest rates, but only if the promise is believable.
Blustering can be counterproductive if markets believe it's just a bluff.
Treasury Secretary Hank Paulson tried to stop a run on Fannie Mae and Freddie Mac by declaring that he had a "bazooka." It turned out that Paulson would have needed a tank, if not a tactical nuclear weapon, to defend Fannie and Freddie.
European Central Bank President Mario Draghi has temporarily calmed markets by declaring that "the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." Now Draghi has to prove that it will be enough. Which leads us directly to Lesson #3
3) Go big. Policy makers are predisposed to incrementalism. Most problems will go away (at least disappear) if they are ignored. And policy makers always assume that they can do more if needed, but they can never undo what they've already set in motion. Political compromise naturally leads to small steps.
But some crises demand bold action, and often you only get one chance. Sometimes, even in economic policy, the Powell Doctrine should govern. Overwhelming force is better than half measures.
If you are jumping off a cliff, it's best to jump out as far as you can so you'll avoid hitting the rocks at the bottom. If you are going to act, act decisively.
4) Saving the banking system is different from saving the economy. As the central bank, the Fed is highly attuned to the vital role banks play in our economy. Without a functioning financial system, our economy cannot work.
The Fed did save the banking system in late 2008 and early 2009, but the task of saving the economy remains unfinished. Policies that strengthen banks without stimulating credit or growth should be seen as failures. Maybe the Fed needs to try policies that bypass the banks completely, if it wants to have a positive impact on the real economy.
5) Inflation is not the problem, it's the solution. Constantly worrying about inflation is a central banker's job. But right now, the economy could use a little more inflation, not less.
Bernanke knows inflation -- especially higher wages -- is part of the answer to our problems, Why is that so? Although we don't have genuine deflation right now, the economy is suffering from near-deflation. Because of the unsustainable debt that was built up, the private sector wants to save all it can, and the public sector does too. Inflation would make the debts easier to repay, and it would give everyone an incentive to spend a little more.
But Bernanke also knows that it's next to impossible to change the Fed's institutional DNA on inflation.
What can these lessons tell us about what Bernanke and the Fed will do next?
First, the Fed won't ride to the rescue. This week, the Federal Open Market Committee will meet to consider further purchases of bonds, but most analysts believe the committee will delay doing so.
The FOMC could decide to implement an aggressive bond-buying program, but it would take at least $1 trillion to boost the economy by even a half percentage point. The Powell Doctrine would call for much more.
Or the FOMC could decide to extend its guidance and say it will probably keep interest rates lower even longer. That would be easy to do, but it wouldn't have much direct impact on the economy by itself.
There are other things the FOMC could do, but they are most improbable. The committee could decide to raise its inflation target rate temporarily to encourage inflation expectations to rise, or it could declare that it will keep buying bonds until the economy improves.
The Fed could even start buying Italian and Spanish bonds as a way of lessening the risks of a euro eruption.
But none of those is likely at all. Because Bernanke doesn't have the political power to do the things that he was once confident the Fed would surely do.