Should Bernanke Get a Pink Slip?
The Federal Reserve has been receiving quite a lot of heat these days both from the political right (Newt Gingrich, for example, recently called for Bernanke’s “firing” and labeled him a “disaster”) and from the political left (the Occupy Wall Streeters are no fans of Wall Street bailouts). While there’s plenty to criticize about some of the Fed’s actions, the most reasonable way to determine success or failure is the way we normally do that – by looking at measures of job performance. The Congressionally mandated job requirements for the Fed and its chairman are to use monetary policy to achieve maximum employment and stable prices.
Clearly, we do not have “maximum employment,” so we could give a low grade on this measure although it’s not clear how much of the employment problem is due to monetary policy and how much more the Fed could feasibly do. But this is beside the point since the one thing the Fed’s critics on both the left and the right would agree on is that that Fed should not be pursuing more aggressive policy. Their main complaint has been that the Fed has done far too much, not too little. The only way for Bernanke to improve on the maximum employment front would be to pursue an option that the Fed’s critics have said should be off the table.
That overactive Federal Reserve then must be failed miserably in containing inflation, right? That’s the implication of the criticism, but the data suggest nothing of the sort. Here’s the Bernanke Fed’s inflation record during his tenure at the helm:
The average inflation rate over this period using the all-items CPI was 2.5 percent and the more reliable core-CPI inflation was a mere 1.9 percent. By comparison, the Greenspan Fed had an all-items CPI inflation rate of 3.3 percent on average and a core inflation rate of 3.0 percent.
So Bernanke has not been recklessly generating rapid price inflation but what about the potential for inflation down the road? There are no crystal balls to gaze into but we do have evidence that inflation inflation expectations remain low by historical standards. Here’s the University of Michigan’s Inflation Expectation index (the latest reading on that measure is 3.5 percent):
Wages and labor costs remain low, as Greg Mankiw pointed out here, which do not suggest any significant inflation risks going forward.
Finally, the spread between nominal Treasury bond rates and rates on Treasury Inflation Indexed Securities (TIPS) is one way to measure expected inflation. Here’s the graph, which again suggests that markets are not anticipating rapid inflation either:
The primary function of the Fed, aside from these Congressional mandates, is to act as a lender-of-last-resort. The economic history is useful to keep in mind here: the Fed was the product of the National Monetary Commission (if you’re as odd as I am, you might find the NMC documents fascinating and they are all online here), which was formed in response to the 1907 panic to fulfill just this function. Now, it hasn’t always done that (as Friedman and Schwarz famously pointed out, the Fed contributed to the Depression by being too inactive as it sat by and watched banks collapse in the early years of the Depression). But even before messing things up by abandoning its post as backstop to the American banking system in the Depression, the U.S. clearly needed a lender-of-last resort.
In the gilded age alone, the U.S. experienced panics in 1873, 1884, 1890, 1893 and 1907. Between 1825 and 1929, there were as many as seven major bank panics and 25 minor panics, so the NMC finally decided to do what Alexander Hamilton had tried (successfully for a while) to create well over a century earlier.
Hamilton proposed and created something that looked a lot like a central bank way back in 1791. Hamilton’s bank was modeled after the much older Bank of England (created in 1694), which did not endear him to those who abhorred all things British. But, the First Bank of the United States was chartered anyway and was a success story in American economic history. Unfortunately, its economic success was obscured, as these things often are, in the politics of the day and its charter was not renewed. Only five years later, we backtracked and decided that Hamilton may have been right after all! Thus, the Second Bank of the United States was chartered in 1816 but it too died a political death under President Jackson’s “Bank War.” The U.S. was without a true central bank until 1914 when, for the third time, we decided it might be a good idea and created the Federal Reserve.
So the U.S. has gone through these anti-central bank sentiments before. Ron Paul notwithstanding, I don’t think there’s much chance of a second Jackson Bank War but I do believe it is important to keep in mind why the Fed was created in the first place.
Despite its mistakes and despite any number of squabbles one might have with specific Bernanke Fed strategy, he has not been disastrous. If nothing else, the Bernanke Fed, when faced with a massive financial crisis, acted decisively to prop up the system; in short, it did in 2008 precisely what it should have done from 1929 to 1933. I think Hamilton, and Friedman, would be satisfied.