The Zero Man
Obama’s greatest obstacle to re-election isn’t Mitt Romney, or rising gas prices: It’s Ben Bernanke.
It’s the sort of news that strikes fear in the hearts of incumbent politicians everywhere: the cost of living is rising. And if people really do vote with their wallets, less money in their pockets is a death knell. With the U.S. consumer price index rising 0.4 percent in February — the largest jump in 10 months, largely due to rising gasoline prices — the trend doesn’t look good. On March 23, the International Energy Agency warned that soaring oil prices risk a recession. And in a testament to the issue’s political resonance, GOP candidate Newt Gingrich even pledged (however utopian this may be) to lower the price of gas to $2.50 per gallon in an effort to revive his flagging presidential hopes.
But while rising gas prices may dim President Barack Obama’s reelection prospects, Federal Reserve chairman Ben Bernanke is not likely to lose much sleep over it. Bernanke’s own research, dating back to 1995, has convinced him that it is central banks’ decision to tighten the money supply by raising interest rates that triggers economic downturns — not the spike in oil prices itself. And so long as the Fed doesn’t raise interest rates in the face of rising oil prices, Bernanke’s thinking goes, the spikes should be harmless. Even if oil prices were to jump through the roof, it is highly unlikely that the Federal Reserve would raise interest rates in an effort to combat inflation.
How can we be so sure of that? Under Bernanke’s stewardship, the veil of secrecy over the Fed’s actions that existed under his predecessor, Alan Greenspan, has been lifted. Back in those days, being a Fed-watcher was an actual profession — trying to decipher what Greenspan himself dubbed Fed-speak: mumbling with great incoherence. Bernanke, on the other hand, vowed during his confirmation hearing in 2005 to make the Fed’s policies more transparent. When financial markets can predict the factors that affect the Fed’s monetary policy, his academic research had convinced him, it is easier for him to keep interest rates where he wants them.
When Bernanke sent his second monetary policy report to Congress in June 2006, he told lawmakers that the decision on a possible rate hike would depend on incoming economic data. No crystal ball — simply data-driven decision-making. But this announcement didn’t have the stabilizing effect that he probably had hoped for: Financial markets fell in disarray, as some data pointed to a rate hike while others suggested that the Fed would keep the rate steady. As one banker at Lehman Brothers mused at the time, "Bernanke is treating us like adults, only to find out we are behaving like children."
When credit markets choked up and international trade plunged after the collapse of Lehman Brothers in September 2008, Bernanke not only flooded the banks with money to keep them afloat, he also quickly cut interest rates. Since then, he has acted to keep rates at historic lows in an attempt to spur economic growth — a step, however, that also appears to contribute to rising oil prices, and hence rising inflation.
With the federal funds rate — the most important short-term rate that the Fed has to influence the economy — at almost zero percent since December 2009, Bernanke has been forced to look for unconventional ways to stimulate the economy and combat high unemployment. He embarked on a strategy of buying trillions of dollars of bonds known as quantitative easing, which aimed to unfreeze the market for asset-backed securities and drive down longer-term interest rates.
In a bid to enhance the Fed’s predictability, Bernanke also launched a policy of holding press conferences immediately after the meetings of the Federal Open Market Committee, which determines short-term interest rates. The pressers are intended to "further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication," according to a press release at the time.
In the past year, Bernanke has only doubled down on his efforts to use the Fed’s communications policy to drive down interest rates by giving investors still more guidance on the future path of the Fed funds rate. On Aug. 9, 2011, the FOMC released a statement saying that it anticipated economic conditions would likely warrant exceptionally low levels at least through mid-2013. This sent shockwaves through financial markets — the volume of stocks traded rose to almost twice the daily average. The FOMC succeeded in its mission to lower bond yields, but it also effectively limited Bernanke’s flexibility to alter course in the face of changing market conditions.
These steps have been successful at keeping interest rates low, but they have also limited Bernanke’s flexibility to raise interest rates if market conditions change. Indeed, in January 2012, the FOMC pontificated that it anticipated exceptionally low levels for the federal funds rate at least through late 2014 — it even included a table that provided a picture of individual committee members’ rate expectations, the first central bank ever to do so. The fact that FOMC members’ expectations about the future Fed funds rate is now down on paper virtually ensures that the Fed will keep the rate near zero until the end of 2014 — no matter how the economic situation develops.
Even if inflation rises even higher and unemployment continues to falls, Bernanke will likely argue that the Fed’s credibility is sufficient reason to keep rates low. That’s what happened at the FOMC meeting in June 2003, when the economy was growing at a healthy clip, but the Fed nonetheless decided to cut the Fed funds rate from 1.25 to 1 percent, since markets were anticipating it. And as we all know now, the Fed’s ultra-loose monetary policy lay the groundwork for the subsequent housing boom, which wrecked the U.S. economy.
Once again, the Fed is at risk of letting financial markets, rather than economic fundamentals, dictate its rate decision. Bernanke’s obsession with predictability aside, recent economic news has given the Fed reason to reconsider its policy of historically low interest rates. Since the January meeting of the FOMC, the unemployment rate has dropped like a brick — albeit to a still unsatisfactory 8.3 percent — and inflation has spiked due to rising oil prices. Given the Fed’s dual mandate (maintaining price stability and promoting maximum employment) these data points suggest that a rate hike, bringing interest rates to more conventional levels, may be nearer than the committee initially predicted.
However, there is no sign so far that Bernanke is preparing to change course. The Fed chief has reiterated his expectation time and again that the Fed funds rate will remain at an exceptionally low level until the end of 2014. Asked during congressional hearings by lawmakers on February 29 and March 1 about the impact of higher oil prices on the economy, Bernanke likened the oil price hikes to a tax on income and was only willing to concede that it would temporarily lead to higher inflation. He painted rising oil prices as a temporary phenomenon, suggesting that they will at some point stabilize (at which point inflation will indeed be close to the Fed’s target of 2 percent), while making the case that the Fed is only concerned with "longer-term" inflation.
Bernanke’s background as an eminent economics scholar is often considered an advantage, but it may just as well be his Achilles heel. Much of his research concentrates on the Great Depression, and his central conclusion was that much of the pain during that period could have been avoided if monetary policy had been loosened, rather than tightened. In a speech on Milton Friedman’s 90th birthday, Bernanke told the eminent economic theorist that the Federal Reserve was indeed responsible for deepening the Great Depression: "You’re right, we did it," he said. "We’re very sorry. But thanks to you, we won’t do it again."
"Moderation is fatal. Nothing succeeds like excess," Oscar Wilde once said. Unfortunately, this aphorism does not apply to monetary policy. Keeping the interest rate low may look good in an election year, but it comes at the expense of higher oil prices. Excessively low interest rates create bubbles and can lead to runaway inflation — not only ruining candidates’ election hopes, but entire economies. Although Alan Greenspan has taken the fall for the 2008 financial crisis, Bernanke was the ideologue who provided the intellectual backing for the aggressive rate cuts in the early 2000s that set us up for the Great Recession. Obama may be focused on high gas prices these days, but the larger problem is that Bernanke’s policies may be undermining his economic stewardship.