As long as Democrats control the White House or at least one chamber of Congress, they will not let lawmakers clip the Fed’s wings. But Republicans could protest (and have) by throwing obstacles before nominees to the central bank’s Board of Governors or proposing legislation to audit its interest-rate decisions—proposals that the Fed sees as threats to its independence, sources there say.
WHAT BEN KNOWS
Bernanke, famously, sees the Great Depression—the focus of his academic work—as a foundational event. “He said, ‘Well, look, if you want to understand geography, study earthquakes,’ ” says Mark Gertler, Bernanke’s longtime friend and coauthor. “The Great Depression was the greatest economic calamity in modern times, so his feeling is he’d get insights about the economy by studying the Depression.” The chairman declined an on-the-record interview for this story.
When he studied the Depression’s bank failures and credit turmoil, Bernanke found that those conditions weren’t merely symptoms of the crisis; they were factors in worsening it. The takeaway: When credit markets seize up, they must be repaired to prevent broader damage to the economy. Growth is not just the end, but also a means, of recovery. Those conclusions built on the work of economists Milton Friedman and Anna Schwartz, who had linked overly tight monetary policy—caused by the adherence to the gold standard—to the severity of the Depression.
Central bankers’ caution makes sense in normal times, Bernanke has argued, but they must be willing to try unorthodox methods in a crisis, as President Roosevelt did when he abandoned the gold standard in 1933 and created the Federal Deposit Insurance Corp. “The country is lucky that it was Bernanke who was chairman during these exceptional times,” says former Federal Reserve Governor Laurence Meyer, now a senior adviser to the research firm Macroeconomic Advisers. “He wrote the playbook of what policy tools were available when you hit the zero bound [on interest rates]. And, basically, he went through that playbook.”
The country first got a peek at this playbook in a speech Bernanke delivered to the National Economists Club in November 2002, shortly after he left Princeton University to become a Fed governor. He outlined a set of unconventional tools the bank could theoretically use if it were ever confronted with 1930s-style deflation: commit to keep short-term rates low for a specific period; make loans to the private sector indirectly through banks; and buy foreign or domestic government debt that it could use in case its main policy lever, short-term interest rates, ever approached zero.
When Bernanke was nominated as Fed chairman in 2005, liberals worried that he might focus too much on price stability. As an academic, he had advocated inflation targeting, a practice used by other central banks in which they spell out specific inflation goals, helping investors predict when they might raise and lower interest rates. To some Democrats, this was code for caring more about inflation than employment. But Bernanke has always said that the dual-mandate serves the country well.
And when the financial crisis struck, he proved it by bringing out his 2002 playbook. The original fear was deflation, but he put it to work against joblessness, too. In 2008, the Fed explicitly cited “maximum employment” in a policy directive, something it hadn’t done in the 30 years since the adoption of the dual mandate, according to a study by Daniel Thornton, a senior official at the St. Louis Fed. It also provided loans to institutions other than commercial banks for the first time since the 1930s. It orchestrated the takeover of investment bank Bear Stearns and lent emergency cash to insurance giant American International Group. Between December 2007 and December 2008, the central bank chopped the federal-funds interest rate down from 4.25 percent to near zero.
Since the rate couldn’t go any lower, the Fed then began buying up securities in 2008, including mortgage-based and Treasury bonds, as way to inject more money into the struggling economy. It racked up $1.7 trillion in purchases during that first round of quantitative easing, which continued into 2010. QE2, an additional $600 billion in purchases, followed in November 2010, and QE3 began in September 2012. This last was particularly unorthodox. Rather than buying a fixed amount, the Fed made an open-ended pledge to purchase tens of billions of dollars in mortgage-backed securities each month until the labor market improved “substantially.” The bank now has $3 trillion worth of assets on its balance sheet, more than triple what it had in 2008. This was no longer solely about prices.
The more the Fed experimented, the more inflation hawks grumbled that attempts to bring down unemployment were sowing future economic risks. By the time QE2 got started, a New York Post headline declared, “Open Season on Ben.” During the Republican presidential primaries, Mitt Romney, Newt Gingrich, Rick Perry, and Herman Cain all vowed to replace Bernanke, a Republican, if elected. Perry threatened: “If this guy prints more money between now and the election, I don’t know what you all would do to him in Iowa, but we would treat him pretty ugly down in Texas.” (Unfazed, Bernanke did a town-hall meeting with soldiers and their families in Fort Bliss, Texas, three months later.) Vitter and Corker began working on their legislation early this year.