Time has named the Federal Reserve chairman its person of the year. I think this choice says a lot — perhaps not all of it as the magazine’s editors intended — about where we’ve been, where we are and where we’re going.
1. Where we’ve been: There have been a lot of factors blamed for the housing bubble, financial crisis and subsequent recession. The causes of the collapse certainly were complex, but no single factor sticks out in my mind more than the easy-money policy that the Fed pursued under Alan Greenspan — with Bernanke at his side for much of the time when trouble was brewing.
Monetary policy is a powerful way to influence the economy, probably more powerful than any spending or tax policies can be. But that potency also makes it very difficult to rein in monetary policy at the right time and to the right degree. There can be little doubt that the Fed kept flooding the world with dollars far too long after the recession induced by the bursting of the tech bubble and the 9/11 attacks. This flood is a key reason banks were willing to loan money to subprime borrowers. Securitization of mortgages played a big role here as well, but the loans that were securitized would have been less likely to have been made in the first place if money hadn’t been so cheap.
S&P’s chief economist, David Wyss, noted yesterday at the unveiling of UGA’s 2010 Economic Outlook that this recession has been more coordinated globally than any other — even the Great Depression. He talked about the interconnection of world markets, particularly financial markets, as a reason for this. This interconnection exacerbated the Fed’s policies by globalizing them.
2. Where we are: The Fed may have helped cause the housing bubble, but historians will probably rate its response to the financial crisis favorably. It was the Bush Treasury, remember, that responded so inconsistently to bank troubles (bail out Bear Stearns; let Lehman Brothers fail) as to turn a credit crunch into a full-blown financial panic. The Fed was left to overcome an even more severe credit crisis, and Bernanke was determined not to allow another depression — as the Fed had helped to do in the 1930s. Here, the Time editors are correct that our “weak economy…could have been much, much weaker” if not for the Fed’s efforts.
The Fed wasn’t perfect, but it was probably as good as we could have expected it to be.
3. Where we’re going: The satirical magazine The Onion wrote this snarky headline in July 2008: “Recession-Plagued Nation Demands New Bubble To Invest In.” And life may end up imitating satire if the Fed leaves the spigots on too long.
Commodity prices and price indexes indicate that inflation is back to normal and headed higher. There are many reasons why the current rebound is weaker than the usual post-recession rebound, but inflation expectations are surely one of them.
It sounds cruel to say this after he’s endured the last 18 months, but the real test of Ben Bernanke will be whether he has the guts to tighten monetary policy before it’s popular to do so, and while politicians howl for it to remain loose. That test will determine whether Time’s choice of Bernanke still looks good a few years from now.