Sunday, February 19, 2006
Bernanke and King
Posted by David Smith at 02:00 AM
Category: Thoughts and responses

No Sunday Times article this week, but here's something else, after an interesting week.

Ben Bernanke, the new chairman of the Federal Reserve, made his debut this week. By coincidence, his old MIT room-neighbour, Mervyn King, was expounding on monetary policy in the UK. What's the connection? Read on.

Bernanke's debut, in testimony to Congress, was a success. Here's a reflection on it from the Associated Press:

"NEW YORK Alan who? By the time Ben Bernanke completed his debut before Congress as chairman of the Federal Reserve, economists were enthralled, investors were encouraged, stocks were higher and pulses on Wall Street were lower. The nervousness that had crackled over trading floors in recent weeks _ fears that Bernanke wouldn't be tough on inflation and concern that an academic like him couldn't master Washington's realpolitik _ were swept aside.

"He not only was articulate in his views, but justified his views without making financial markets balk," said Anthony Chan, chief economist at JP Morgan Private Client Services. "He was impressive, maybe not as impressive as Greenspan, but Greenspan had 18 years to practice."

Bernanke displayed two marked contrasts to his predecessor: An ability to communicate in plain English and an unwillingness to tackle issues outside monetary policy. In some instances, he showed both at once.

Asked if taxes were too high, he replied, "Compared to what?" Asked whether inequality should be considered when cutting taxes, he said, "These are value judgments. It's what people have elected you to do, and clearly it's your responsibility."

That was a marked contrast to Greenspan, who has not been afraid to take a public stand on policy issues such as tax cuts.

Still, what markets wanted and what Bernanke had promised was a smooth change in leadership at the Fed. The day he was nominated, Bernanke said, "If I'm confirmed to this position, my first priority will be to maintain continuity with the policies and policy strategies established during the Greenspan years."

Judging from his testimony, the leadership change is going well, economists said.

"You can't ask for 100 percent seamless transition, but this was as close as you get," said Quincy Krosby, chief investment strategist at The Hartford Financial Services Group Inc., the Connecticut-based insurance company.

And the substance of what he said didn't differ markedly from what Greenspan had been saying before he retired. "The market heard nothing really new out of Bernanke," wrote Brian Williamson, equity trader at The Boston Company Asset Management, a Mellon Financial Corp. subsidiary. "He will continue Greenspan's monetary policy. The news was enough to spark a mini-rally in most US indices."

The mix of Bernanke's reassuring performance and positive economic data sent the major indices higher Wednesday and Thursday, sending the Dow Jones industrial average to 4 1/2 year highs _ despite the fact that Bernanke's testimony left the door open to two more Fed increases in short-term interest rates, which is more than the market anticipated.

The change in speaking style was what struck Sherry Cooper, global economic strategist for Harris Bank of Chicago. "I thought it was a breath of fresh air. I thought it was wonderful. I kept looking up, thinking, 'Is that really the Fed chairman?' It sounded almost like a course, junior year macroeconomics. He was very clearly explaining to the committees what's going on in the economy, what he will be thinking about in his decisions."

There are some in the financial world who say the testimony is nothing more than a form of theater, albeit a form of theater that is now more like a mainstream Broadway show and less like an indecipherable version of Samuel Beckett."

So he went down well. King, in contrast, had a tougher time. His insistence that consumer spending was picking up was followed by official figures showing that UK retailers had their toughest start to the year since 1945. I don't quite believe it either, but sales volume was down by 1.3% on the month. The Bank governor also had to defend the monetary policy committee's forecasts against the accusation that they were too optimistic on growth and too pessimistic on inflation.

King is in a difficult position. His central banking colleagues in Washington, Frankfurt and even Tokyo are in the process of tightening monetary policy. The Bank has been there, raising rates from 3.5% to 4.75% between November 2003 and August 2004. But the governor was against last August's cut, and he may be the last MPC member to accept the need for another one.

He, like Bernanke, knows the importance of signalling. He genuinely believes the evidence is too ambiguous to justify a cut in rates. He also thinks it is time to wean the economy off its reliance on consumer spending. If that means a temporary slowdown, so be it, for the sake for the sake of the economy's longer-term health. If it means inflation drops below target for a time, so be it too.

We have yet to see how democratic the Federal Open Market Committee will be under Bernanke. Under Alan Greenspan the chairman's writ ran large. King has only one vote, like the other MPC members. He may find that frustrating in the coming months.