Greenspan's legacy weighs on Bernanke's prospects

As Ben Bernanke prepares for next month's Senate hearings on his nomination as chairman of the Federal Reserve Board, commentators have warned of the challenges ahead if he succeeds.

Rising inflation, soaring house prices and a ballooning current account deficit could all provide headaches for the former Princeton economics professor from South Carolina.

But perhaps the biggest challenge facing Bernanke as he takes up the world's most powerful financial job is the fact that he is not Alan Greenspan. After 18 years at the Fed, Greenspan has achieved an almost mythic status that has reassured markets that a wise hand is guiding the American economy.

Greenspan's pronouncements were often opaque but they carried the authority of a central banker so confident in his own judgment, and with such a sure instinct for the market they were always effective.

Bernanke, a former university professor known for his plain talk, is expected to be far more clear in his pronouncements than Greenspan, whose speeches often are shrouded in obscure language. David Kelly, managing director of Putnam Investments in Boston, even wonders whether Bernanke would be too talkative for his own good.

Bernanke has promised continuity and, as a former Fed governor, he is already familiar with the institution he is about to lead. In three years of serving under Greenspan on the Fed, Bernanke sided with the chairman on every decision to move interest rates up or down or to leave them alone.

But Bernanke, nominated on Monday by President Bush to become the next Fed chairman, is no clone of the 79-year-old Greenspan. Their distinctions are more in style than substance, analysts say, but that could make a difference in interest rate policy and crisis management.

History shows that Fed chairmen are tested by unexpected crises during their first months in office and Bernanke's fate may be no different. Greenspan saw the stock market crash two months after he came to the job in 1987; his predecessor Paul Volcker had to deal with a rout in the bond market three months after he became chairman in 1979; Volcker's predecessor faced a dollar crisis as soon as he took office a year earlier.

Bernanke appears well prepared to deal with the most obvious challenge facing the Fed - rising inflation fuelled by high oil prices. Retail energy prices have risen by 35 per cent in the last year and some US economists fear that, as in the 1970s, the effect could spill over into other sectors.

Unlike his predecessor, Bernanke favours setting a target for inflation similar to the European Central Bank's aim of keeping annual price rises close to 2 per cent.

"Announcing an actual number or range would serve to anchor public expectations of inflation more firmly and avoid the risk of 'inflation scares'," he said in an interview last year. "I don't see him setting a bunch of inflexible rules," said Ethan Harris, an economist at Lehman Bros in New York.

To Bernanke, Harris said, the appeal of targeting is that the stock and bond markets are less nervous when they know what policies the Fed is pursuing.

Gus Faucher, a senior economist at Economy.com, agrees. "He's not so dogmatic an inflation targeter that he ignores everything else that's going on in the economy.

"Inflation targeting is a continuum, and it's a question of how far down the spectrum he'll go."

Nariman Behravesh, chief economist with consulting company Global Insight, predicted that Bernanke generally would reach the same conclusions as Greenspan even if his methods might be different.

Unlike the ECB, the Fed has a mandate that goes beyond ensuring price stability to include a responsibility to encourage economic growth and employment. As US core inflation hovers around 2 per cent - the upper level of Bernanke's favoured target range - the Fed will have to judge its interest rate policy carefully to avoid a crash in America's buoyant housing market.

As chairman of President George W Bush's Council of Economic Advisers, Bernanke backed the administration's tax cuts which have helped to drive up the US budget deficit. He is also relaxed about the country's massive current account deficit, which was running at an annual rate of almost $800 billion (€659 billion) during the first half of 2005 and requires foreign funding of $3 billion per business day.

For Bernanke, the problem is not that Americans are saving too little but that foreigners are saving too much and should be encouraged to go on a shopping spree. The current account deficit could become a problem for Bernanke, however, if foreign exchange markets take fright at the departure of the reassuring Greenspan and provoke a dollar crisis. This would increase pressure to put up interest rates faster than the housing market could bear, triggering a property crash.

Writing in the Washington Post this week, David Ignatius suggested that, if Bernanke is to be as successful as his predecessor, he must cultivate agility as well as rigour.

"The Maestro didn't have a magic wand. Greenspan was smart, and he was lucky - but most of all he was flexible, and willing to adapt his ideas when he sensed that the economy was moving to a different rhythm than what the academic economists would have predicted.

"Bernanke's challenge will be to combine the monetary discipline the markets expect with a Greenspan-like suppleness of mind. "The world economy will turn on his ability to learn quickly on the job," he said.

(Additional reporting: LA Times Service)