Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AmericasDecember 5 2005

New Fed chairman needs to act decisively

Alan Greenspan may have left his successor a legacy of policy credibility but with it comes an economy that is worse for wear.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

They call him the maestro but US Federal Reserve chairman Alan Greenspan’s ultimate masterstroke may prove to be the timing of his retirement from the job, bequeathing his successor-designate Ben Bernanke an economy in dubious shape.

Mr Bernanke sailed through the US Senate confirmation hearing that was notable for his first official but widely anticipated comments in support of inflation targeting. Though, in the manner of a seasoned central banker, he quickly cooled expectations that he would act with undue haste.

It is something of a fiddly point, as the Fed already implicitly targets inflation, it just doesn’t say what that target is. The hoopla over Mr Bernanke’s comments was akin to finding an important piece of a puzzle; only the puzzle – how Mr Bernanke will direct Fed policy – is far from complete.

More worrisome is what Mr Bernanke will make of the behaviour of US long-bond yields, which remain suppressed despite 12 25-basis point hikes of the federal funds rate since June 2004. In Greenspan-speak, it is a “conundrum”. And with the futures market anticipating a further tightening, it is not inconceivable that the US could be facing an inverted yield curve, traditionally the harbinger of recession.

Complex picture

It is actually a bit more complicated than that. Indeed, Mr Bernanke coined the phrase “global savings glut” to highlight particularly Asian appetite for US Treasuries, keeping their currencies down and exports competitive; propping the dollar up and fuelling US imports; and funding the US capital account deficit that has arisen. But after cutting interest rates in response to the 2001/02 recession, was Mr Greenspan too slow to tighten in 2003? Has this led to a housing market bubble? If inflation picks up, will excessive monetary tightening prick the housing market bubble, triggering a collapse in consumption? And what if Mr Bernanke starts cutting rates just as Europe and Japan are raising them – will this trigger a precipitous decline in the dollar?

Mr Bernanke has sound academic credentials to get his head around the problem; it is his relative lack of policy-making experience that spooks the markets. If, as expected, he is confirmed for the job, he will inherit the Fed’s policy credibility, one of Mr Greenspan’s legacies.

But markets are fickle and Mr Bernanke will have to act decisively to keep that confidence if and when the US economy hits rough waters.

But then again, central bankers secretly relish a crisis to prove their mettle.

Was this article helpful?

Thank you for your feedback!

Read more about:  Analysis & opinion , Americas , US