Bernanke saved the day, but unresolved questions remain about central banking
Knowledge of economic history helped Bernanke halt a terrifying panic, but he also made mistakes
Ben Bernanke, soon to be ex-chairman of the US Federal Reserve, will surely be regarded as one of the Fed’s most significant chairmen. Photographer: Andrew Harrer/Bloomberg
In their patter song in The Pirates of Penzance, Gilbert and Sullivan satirised the notion of an educated “modern major-general”. Today they might satirise academic central bankers, of which Ben Bernanke – soon to be ex-chairman of the Federal Reserve – is the very model. As a distinguished scholar, he brought to the Fed a brilliant and well-informed mind.
His knowledge of economic history helped him halt a terrifying panic, but he also made mistakes. History will probably judge him kindly. But there is much to be learnt from his time at the Fed.
Bernanke was hugely influential even before he became chairman, in 2006. As governor from 2002, he made notable contributions, including his 2002 “making sure ‘it’ [Japanese-style deflation] doesn’t happen here”, and his 2004 celebration of the “great moderation”.
Before this, not least in a 1999 paper co-authored with Mark Gertler of New York University, he had argued that “the best policy framework for attaining [price and financial stability] is a regime of flexible inflation targeting”. This is the core dogma of modern central banking.
In a valedictory this month, Bernanke started with “transparency and accountability”, pointing to the fact that, in January 2012, the Federal Open Market Committee “established, for the first time, an explicit longer- run goal for inflation of 2 per cent”.
He added that the Fed’s transparency and accountability proved “critical in a quite different sphere – namely, in supporting the institution’s democratic legitimacy”. He was surely right. Central banks wield great power. Transparency and accountability are vital if its exercise is to be both effective and legitimate.
Another area on which Bernanke focused was financial stability. Here, in the run-up to the crisis, he made two mistakes.
First, in his 2004 praise for the great moderation – the vainglorious label given to the performance of the US economy before the largest financial and economic crisis for 80 years – Bernanke claimed that “better monetary policy may have been a major contributor to increased economic stability”. In this, he displayed the blinkers of his profession.
As the disregarded economist Hyman Minsky tried to tell us, stability destabilises. An active and enterprising financial system creates risk, often by raising leverage dramatically in good times.
Second, Bernanke missed the implications of subprime mortgages. Thus, in May 2007, he remarked that “we believe the effect of the troubles in the subprime sector on the broader housing market will probably be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”.
Fortunately, when it became evident that this judgment was in gross error, the Bernanke Fed acted decisively and effectively, slashing interest rates and sustaining credit. Panic-fighter Bernanke followed the guidance of the great Victorian economic journalist Walter Bagehot, who urged unrestricted lending by central banks to solvent institutions in times of crisis. This is a world of manias and panics. Happily, Bernanke knew this.