Gentle Ben

Now that we've had a chance to digest Dr. Bernanke's nomination a bit, it's high time to begin brashly speculating about what kind of Fed Chairman he'll make.  The markets are doing so, like it or not, so we may as well keep pace.

In Bernanke's first post-nomination address yesterday afternoon, he declared continuity to be his primary objective.  I have no doubt he'll make good on this pledge.  But at some point, his tenure will bend to his own brand of monetary policy.  So an understanding of the nominee's economic philosophy (and in particular, where and how it may differ with Dr. Greenspan's) could be illuminating.

It's been a while since we had top-of-the-Temple turnover (Greenspan succeeded Paul Volcker in 1987), but two key dimensions one might use to characterize any Fed Chairman are 1) stance on inflation, and 2) involvement in fiscal issues (taxation and spending).

The first actually consists of two sub-dimensions (don't worry, no string theory coming).  Monetary policy philosophy as relates to inflation involves not only one's opinion on the presence and levels of inflationary pressures, but also one's degree of hawkishness toward combating those pressures.  In other words, Bernanke parting company with Greenspan on the specter of inflation and/or how hard inflation ought to be fought could both impact the future path of interest rates.

Whereas Greenspan has been unrelentingly hawkish on keeping the evils of inflation at bay (current streak is 11 consecutive fed funds rate increases, and previous monetary tightening under his watch has been causally tied to the 1987 crash and the 1990-91 recession), evidence suggests Bernanke may be more tempered.  From his October 20th Economic Outlook:

Long-term-inflation expectations also remain low and stable, based on measures of inflation compensation derived from inflation-indexed Treasury securities ... [T]he stability in core inflation and inflation expectations does suggest that overall inflation is likely to return to levels consistent with price stability in coming quarters.

Add to that his comments on housing prices and real growth...

House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.

...and you've got an economist that sounds decidedly unworried about inflation.

Why then, upon Bernanke's nomination, did futures markets suggest an increased presumption of rate increases?  From the New York Times:

The odds that the benchmark short-term rate would hit 4.5 percent by April, up from 3.75 percent today, reached 94 percent yesterday, according to a futures contract tied to Fed policy. At the start of the day, the odds had been 82 percent.

Bernanke would surely see to a smooth and continuous crossover to his stewardship at the Fed, despite any minor disparity between his and Greenspan's monetary philosophy.  But to foresee his installment as further cementing anticipated rate hikes seems like a misread.

The hawkishness the markets seem to be pricing into Bernanke's policy stance may suggest that, despite yesterday's impressive equity market rally, there's unrealized market upside in this nomination (assuming the rate futures and equity markets are non-arbitrageably rational, which may be a naively heroic assumption).

As to the second dimension, that of fiscal policy involvement, it too breaks down into two component parts: 1) political stance and 2) appetite for involvement.  Strictly speaking, the Fed Chairman's domain doesn't extend beyond monetary policy (money supply and interest rates), mutually exclusive in its purist form from fiscal policy (taxes and government spending).  But when potentates of a certain stature and credibility have opinions, people tend to listen.

Greenspan is probably aptly described as a highly-involved fiscal conservative.  Where Bernanke falls in that spectrum, only time will tell.  As an academic without direct Wall Street experience, one might expect a kernel of fiscal liberalism to be lurking under the surface.  On the other hand, his monetary policy seems if anything to be more laissez-faire than Greenspan's, so that may well carry over into his fiscal perspective.  Whatever his politics, it's hard to predict how vocal he'll choose to be from atop the Fed.  If he reverts to the mean of past Chairmen, we can probably expect a somewhat lesser involvement than we've come to expect from Greenspan.

Above all else, Dr. Bernanke is undeniably erudite and a brilliant economic thinker with gleaming credentials.  Let's just hope no media-hungry Senators make the mistake of unduly forestalling his nomination solely for sake of combat.  I'm sure the resulting debate would be amusingly one-sided, but not quite worth the injurious effect on the process.

Additional contemplation:

• Noam Scheiber at The New Republic weighs in on (among other things) Greenspan vs. Bernanke on fiscal politics.
• Business Week has a cheat sheet of Bernanke's policy comments while a Fed Governor.
• Bloomberg considers whether Bernanke will implement an inflation target.