WASHINGTON — Ben Bernanke argued for 15 years that the Federal Reserve should announce a numerical inflation target. When he finally got his way in January, the victory allowed the central bank to elevate its other mandate: full employment.
By adopting a 2 percent inflation goal, the Fed chairman sought to cement the central bank’s hard-earned credibility for keeping prices low after a 30-year fight against inflation. Bernanke calculated that doing so would anchor expectations for price changes, giving policymakers greater freedom to unleash new stimulus targeted at creating jobs.
So far, the move has worked: The Fed embarked on a third round of quantitative easing in September without unhinging inflation expectations.
Bernanke’s shift to emphasizing employment goals is one of the hallmarks in a grueling two-term chairmanship that spanned the worst financial crisis and recession since the Great Depression and a slow labor-market recovery that pinned joblessness above 8 percent for 43 months.
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Bernanke has explicitly returned the U.S. central bank to the broader, more balanced goal that Franklin Roosevelt described in 1937 as seeking “the greatest attainable measure of economic well-being, the largest degree of economic security and stability” when the then-president inaugurated the Fed’s Beaux Arts-inspired headquarters in D.C.
“This is a Federal Reserve that helped save the world,” said Frederic Mishkin, a Fed governor from 2006 to 2008 and now a professor of banking and financial institutions at Columbia Business School in New York. “Were there risks to doing so? Absolutely. But sometimes you have to take a tough stance, not knowing exactly what the right thing to do is.”
Some Fed chairmen are defined by crises and how they failed or met the challenge. Paul Volcker is remembered for his battle against inflation during his 1979 to 1987 tenure, when he allowed the federal funds effective rate to rise as high as 22 percent to tame annual price acceleration approaching 15 percent. Bernanke’s increased emphasis on job creation is a product of his era and its economic weakness, said Federal Reserve Bank of New York President William C. Dudley.
The 58-year-old Fed chairman, who once wrote that an understanding of the Great Depression would be the “Holy Grail of macroeconomics,” served as a governor from 2002 to 2005 when the central bank neglected to take action to slow the housing bubble. He became chairman in 2006 and in March 2007 told the Joint Economic Committee of Congress that “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”
The 18-month recession began in December 2007, and in March 2008 Bernanke used the Fed’s balance sheet to buy up high-risk securities from Bear Stearns to save the firm from collapse, establishing the central bank’s role as the nation’s main rescue agent.
He shunned orthodoxy as the housing-finance bubble began to deflate and pushed the Fed to “the very edge of its lawful and implied powers,” Volcker said in a 2008 speech. Bernanke gave out more than $2 trillion in emergency aid through six loan programs, currency swaps with other central banks and the rescues of Bear Stearns and American International Group.
“It’s a little bit of an accident in history that this guy who did all of this work on the Great Depression got the chance to take the wheel,” Dudley said.
The force with which Bernanke has attacked joblessness has distinguished him, Dudley said. By expanding the central bank’s balance sheet to a record of almost $3 trillion through asset-purchase programs and keeping the federal funds rate near zero for an unprecedented four years, Bernanke has established himself as history’s most bold and experimental Fed chairman in trying to spur growth.
“Bernanke’s legacy is in being very creative and aggressive in response to an adverse economic environment,” said Dudley, who is also vice chairman of the policy-setting Federal Open Market Committee. He has shown “it’s OK to be aggressive on monetary policy because there are long-run costs of not getting back to maximum sustainable employment quickly.”
Even after emergency lending programs were unwound, he continued to innovate, engaging in three rounds of outright bond purchases known as quantitative easing, aimed at lowering long- term yields with the benchmark rate stuck at zero.
The risks posed by the Fed chief’s policies — including whether the central bank can withdraw its record accommodation before it sparks a surge in inflation — may prove to be the test for Bernanke’s successor, as his second term ends in January 2014.
The White House declines to comment on prospects for a third term, and Bernanke said at a Sept. 13 news conference that he doesn’t “have any decision or any information to give” on his personal plans.
The chances of Bernanke accepting a third term under Obama “are quite low,” said former Fed Vice Chairman Don Kohn, now a senior fellow at the Brookings Institution in Washington, D.C. “Eight years of this kind of pressure under the magnifying glass, taking difficult, difficult positions; he must be looking forward” to doing something else.
The potential for the unprecedented expansion of the Fed’s balance sheet to spark a rapid acceleration in prices has landed Bernanke, former chairman of Republican President George W. Bush’s Council of Economic Advisors, in his own party’s cross hairs.
“We’re only halfway through this experiment,” said Ethan Harris, co-head of global economics research at Bank of America in New York. “So far, the quantitative easing has probably been a small stimulus to the economy and has not created an inflation problem. So far, it’s a partial success. The question then becomes, how hard is it to exit?”
The Fed’s second round of asset purchases, dubbed QE2, ran from November 2010 through June 2011 and unleashed the worst political backlash against the U.S. central bank in three decades. Unlike the criticism Volcker faced, the arguments from lawmakers this time were for tighter monetary policy: Republicans from House Speaker John Boehner of Ohio to Rep. Ron Paul of Texas warned that the measures risked inflation, and QE3, announced Sept. 13, immediately sparked renewed attacks.
The concern that Bernanke’s policies threaten price stability has led some Republicans to seek a change in the Federal Reserve Act that would restrict the Fed’s focus solely to that goal, stripping the central bank of its jobs mandate. The Sound Dollar Act — introduced in March by Rep. Kevin Brady, of Texas, the Joint Economic Committee’s top Republican — currently has 48 co-sponsors in the House.
“I hope we can move to a single mandate,” Sen. Bob Corker, a Tennessee Republican on the Senate panel with Fed oversight authority, said in September. “We are going to continue to champion that.”
While Congress affirmed “maximum employment” as a goal in the Federal Reserve Act in the 1970s, the phrase didn’t appear in an FOMC policy statement until September 2010, according to research by the Federal Reserve Bank of St. Louis. The more explicit reference to the dual mandate is notable because it was ignored for so long by Bernanke’s predecessors, said Benjamin Friedman, an economist at Harvard who has written extensively about central-bank goals.
While Alan Greenspan pursued policies that paid heed to employment — joblessness fell to 3.8 percent in April 2000, a 30-year low — his Fed spoke and acted as if its main job was fighting inflation. The FOMC statement from May 16, 2000, described central bankers’ goals as “price stability and sustainable economic growth,” with no mention of employment or labor.
“They are pursuing both objectives, but they were always trying to pretend that they weren’t” as they tried to bolster their inflation-fighting credibility, said Friedman, who added he never expected Bernanke to be the chairman who gave full-throated expression to the maximum-employment goal both in the statement and in policy.
As an economics professor, Bernanke’s writings advocated constrained discretion and transparency in central banking, while acknowledging its limits.
“When monetary-policy makers set a low rate of inflation as their primary long-run goal, to some significant extent they are simply accepting the reality of what monetary policy can do,” he wrote with three other economists in a 1999 book on inflation targeting.
When Fed officials adopted their inflation goal in January, they didn’t add one for joblessness, saying it would “not be appropriate” to do so because the elements that determine maximum employment “change over time and may not be directly measurable.”
The inability to pinpoint a jobs target, or even potentially influence hiring directly, didn’t stop Bernanke from issuing in September one of the most aggressive statements in Fed history. In addition to pledging to buy $40 billion of mortgage-backed securities a month, the central bank said it doesn’t plan to raise interest rates until at least mid-2015 and policy will remain accommodative “for a considerable time,” even after the economy strengthens. The Fed echoed that statement after its Oct. 23-24 meeting.
For Bernanke, the Fed’s emergency actions during the financial crisis and its aggressive response to the slow recovery are rooted in his historical understanding of the institution. Congress created the Fed in 1913 to resolve recurring financial panics and expanded its mission to price stability and jobs. To do anything less in his eight years as chairman would not follow the law.
“History will have judged Ben Bernanke to have been an outstanding chairman who did what he had to do under extremely difficult circumstances,” Kohn said.