Thursday, February 22, 2018

Ben Bernanke went from brilliant academic to captain of a foundering ship

Shortly before Ben Bernanke was nominated as chairman of the Federal Reserve in 2005, he paid a return visit to Stanford, where he started his academic career in 1979. In a speech, he recalled that he and his wife, Anna, had rented a house with friends because he was certain that local real estate prices would fall. Instead, prices in the San Francisco Bay Area doubled, then doubled again.

"Since then," Bernanke told his audience, "I've developed a view that central bankers should not try to determine fundamental values of assets."

Indeed, Bernanke's academic work, largely at Princeton, helped shape the conventional wisdom that central banks couldn't spot asset bubbles and shouldn't try to pop things that looked like bubbles. In his first speech as a Fed governor in 2002, he reiterated that trying to judge the sustainability of rapid increases in housing or stock prices was "neither desirable nor feasible."

Over the next several years, he said repeatedly that he saw no clear evidence of a housing bubble. And in 2004, the Bernankes paid $839,000 for a townhouse on Capitol Hill in Washington.

It took a great recession to change his mind.

The recession, prompted by the collapse of the housing bubble that Bernanke — and most other experts — failed to see coming, ended an era of minimalism in central banking. And there is no better marker than the views of Bernanke, the world's most influential central banker, who now argues that the Fed needs to consider a range of previously unthinkable actions, including trying to pop bubbles when necessary, because sometimes the cost of doing nothing is worse.

Bernanke, who plans to step down in January after eight years as Fed chairman, will be remembered for helping to arrest the collapse of the financial system in 2008. This shy, methodical economist who had been expected to serve as the keeper of Alan Green­span's flame — to preserve the Fed's hard-won success in moderating inflation — emerged under pressure as perhaps the most innovative and daring leader in the Fed's history.

But what Bernanke did after the crisis may prove to have even more enduring influence. For almost three decades, the Fed focused on moderating inflation in the belief that this was the best and only way to help the economy. In the wake of the crisis, Bernanke forged a broader vision of the Fed's responsibilities, starting experimental, incomplete campaigns to reduce unemployment and to prevent future crises.

The Bernanke Fed has failed to fully achieve its goals. Growth is still tepid, unemployment still too high, inflation still too low. Some critics continue to warn — so far, incorrectly — that its efforts will unleash inflation or destabilize financial markets.

Yet many of the Fed's experiments are already being emulated by other central banks. And Bernanke's many admirers say it is hard to imagine that anyone else could have done more under the circumstances to restore the economy. Fortunately, they say, his lifelong study of central banking under stress meant that he not only knew the available options but also understood that those options weren't enough. And he had the credibility necessary to persuade a hidebound institution to change quickly.

"It's hard to say that the Fed has accomplished what could have or should have been accomplished," said Michael Woodford, an economist at Columbia University. "Yet in the context of the difficulty of the challenges, the likelihood is that few other central bankers could have been as bold as Ben has been."

Rise of a pragmatist

Bernanke was a rising star at Princeton in 1994 when he persuaded 953 people to elect him to a second job — as a member of the Montgomery Township Board of Education. "I did think he was a little crazy" to add that second role, said Mark Gertler, a New York University economist who was a frequent academic collaborator with Bernanke during the 1990s.

But the move was instead an early sign of Bernanke's restlessness with the theoretical world of academia and his nascent interest in public service.

Bernanke was born in 1953 in Augusta, Ga., was raised in one of the few Jewish families in the small town of Dillon, S.C., and went to Harvard at the urging of friends despite the uneasiness of his parents.

But the trajectory of his adult life really began to take shape at the Massachusetts Institute of Technology, where his doctoral adviser, Stanley Fischer, introduced him to the work of Milton Friedman and Anna Schwartz on the causes of the Great Depression of the 1930s.

Fischer also inculcated the view that government, in moderation, could improve economic outcomes — a pragmatic middle ground in the wars between the Keynesian belief in active management and the hands-off absolutism of rational expectations theory. Bernanke is a pragmatist by nature.

After his nomination to become one of the seven Fed governors was announced in 2002, he sent an email to some former colleagues on the School Board, according to Laurie Navin, one of the recipients.

Bernanke related that President George W. Bush had asked him whether he had ever served in an elected position.

"It may mean nothing here, but I served on my local school board," Bernanke said he told the president. "And Bush said: 'It's good enough for me. You're in.' "

Three years later, Bush made Bernanke the first modern Fed chairman who had ever held elective office.

In his public speeches during his time as a Fed governor, Bernanke gave a two-year master class on monetary policy, reinforcing the perception that he had the intellectual heft to succeed Greenspan. But Bernanke won the job in part by impressing Bush in a different way, according to people briefed on the selection process.

During a brief stint in the White House as an economic adviser, Bernanke had distinguished himself by his willingness to answer the president's questions by saying, "We don't really know, but here's how I think about it."

As the financial system began to fall apart on his watch, it became clear that Bernanke had other valuable qualities: an ability to remain calm under pressure and a deep historical understanding of economic crises. Now he urged his colleagues and staff members to set aside their habitual care and find new ways for the Fed to pump money into the financial system. Bernanke sometimes invoked President Franklin D. Roosevelt's marching orders to throw a lot of stuff at the wall and see what stuck.

"We rolled out 12 new products in 12 months," recalled former Fed governor Kevin Warsh, who worked closely with Bernanke during the crisis period. "The Federal Reserve hadn't rolled out a single new product in a generation. But he said the Fed had to operate fundamentally differently to get through this. Because Ben was in some ways the dean of the academy in monetary policy, he realized how little we knew."

It was a monumental achievement. It was also incomplete. Almost 8 million Americans had lost their jobs.

Hemmed in by reality

There was a time when Bernanke seemed to know exactly how to jolt a country out of economic malaise.

In a swaggering 1999 paper, he accused Japan's central bank of lacking the will to take obvious steps to revive that nation's economy. One prescription, which earned him the nickname "Helicopter Ben," was that the Bank of Japan should agree to offset a large tax cut by buying an equivalent amount of government debt, a strategy that Bernanke compared to a "helicopter drop of newly printed money."

The point was that central banks had plenty of ways to stimulate growth even after flooring the gas by cutting short-term rates to zero.

"I'm not one who worries about zero bounds," he declared.

Yet in the five years since the Bernanke Fed hit that zero bound in December 2008, it has not taken the dramatic steps that Bernanke recommended to Japan. Instead, it has relied on two of what Bernanke once described as the least potent options available to a central bank: declaring that the Fed intends to keep short-term rates near zero until unemployment declines, and "quantitative easing" — buying large quantities of Treasury securities and mortgage-backed securities to accelerate job growth.

"During the crisis, it was clear that they were pulling out all of the stops to try to find a solution, and once the financial system stabilized and the problem was merely 10 percent unemployment, then they moved more slowly," said Laurence Ball, an economist at Johns Hopkins University, who wrote in a 2012 paper that Bernanke has lacked the courage of his convictions.

Bernanke has said that critics misunderstand the context of his writings. He was arguing that central banks always have the power to prevent deflation, as the Fed has done in recent years. He did not initially embrace the idea that the Fed should act with comparable force to spur job creation. That case was made by others, including Charles Evans, the president of the Federal Reserve Bank of Chicago, who called for officials to act as if their hair were on fire.

But even as he grew increasingly concerned about unemployment, and pressed for stronger action, friends and colleagues say Chairman Bernanke found himself constrained in ways that professor Bernanke did not anticipate, and that his academic critics still don't seem to appreciate: by political realities, internal opposition and a heightened awareness of consequences.

Several of his most potent prescriptions, like the helicopter drop, require the cooperation of fiscal authorities. But Congress in recent years has shown little interest in helping to stimulate the economy. Instead, the Fed's efforts have been undermined by federal spending cuts.

The Fed has also struggled to anticipate those cuts — one reason that its stimulus campaign was only slowly expanded to its current scale. Bernanke has acknowledged that the Fed did not do enough in the first years after the crisis.

Perhaps most important, internal resistance has increased with each expansion of the Fed's stimulus campaign as officials fret that the economic benefits are shrinking even as the chances increase that something will go wrong.

"He came in as a brilliant academic — a very smart guy with a very deep background in monetary economics — but it was as an academic," said Donald Kohn, the Fed's vice chairman under Bernanke until 2010. "And one of the things that necessarily happens to you when academic theory meets the real world is you become more aware of the limitations of the theory and the models, and how you need to operate in the real world that may not function the way your models suggest that it should function."

Kohn added that, in his view, Bernanke rose to those challenges.

Last autumn, after months of quiet campaigning, Bernanke won support for two experiments that made job creation the clear focus of Fed policy. The Fed announced in September that it would buy $40 billion a month in mortgage bonds until the labor market outlook improved "substantially." In December, it said it would hold short-term rates near zero at least as long as the jobless rate remained above 6.5 percent.

Bernanke spoke of the Fed's "grave concern" about unemployment. But many of the officials who supported the program did so tentatively, and their growing unease drove the decision for Bernanke to announce in June that the Fed intended to reduce its bond-buying before the end of the year.

Stepping down

As he prepares to step down, Bernanke is starting to let the weight of the past eight years slip from his shoulders. In June, he delivered a lighthearted baccalaureate address at Princeton, looking more comfortable wearing medieval robes than he has often looked in new suits.

"I wrote recently to inquire about the status of my leave from the university," he joked, "and the letter I got back began, 'Regrettably, Princeton receives many more qualified applicants for faculty positions than we can accommodate.' "

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