A Fed watcher outlines Bernanke’s thinking

Ben S. Bernanke’s appointment as chairman of the Federal Reserve was poorly timed. He had hardly gotten his feet under the desk before having to cope with possibly the most testing financial and economic crisis in nearly 30 years.

Ethan S. Harris, author of “Ben Bernanke’s Fed,” an interim report on the new chairman, is in a position to sympathize. His own timing leaves something to be desired.

The book went to press in May, it seems, but the main narrative stops before the Bear Stearns drama in March -- a moderately busy time, one imagines, for Harris, chief U.S. economist and Fed watcher at Lehman Bros.

A reference to the primary dealer credit facility, or PDCF, announced as part of the Bear Stearns rescue, is awkwardly inserted in a list of new Fed “anachronisms” (that should be “acronyms”).

But there is no direct discussion of the rescue, the Fed’s expanded regulatory role, or any of the later events adding to the world of pain in which the chairman finds himself.

A reviewer is duty-bound to say that the book is already out of date -- but it is a tribute to the author that it feels mean to do so. The missing last chapter matters less than one might think.

Regardless, this is an excellent introduction to the art of central banking, and in particular to Bernanke’s thinking and preparation for the job. If you are already an expert in either, you are not the intended reader.

If you are looking for an intelligent layman’s guide to U.S. monetary policy, there is no need to wait for the updated paperback. The first quarter of the book is a well-executed primer on pure and applied central banking. Harris explains in accessible terms the elements of macroeconomic policy, how the Fed works, how the chairman and governors communicate and why it matters if they fail to.

The next two chapters are about the Greenspan years, one each for successes and failures. This is a nicely balanced account. Harris gives the former chairman credit where it is due, but argues that the mystique that has grown up around the man is vastly overblown. Greenspan is lauded too much by his fans and too bitterly attacked by his critics.

Harris acknowledges Greenspan’s “enviable” record while noting “his share of policy and forecasting errors.” At some length, the book disagrees with Greenspan’s (and Bernanke’s) position that central banks should not try to curb asset-price bubbles as they are inflating, unless they are pushing up prices in general.

Preemptive action on interest rates, Harris says, would be more difficult and would have to be more circumspect than many believe, but is still worth a try.

Six chapters follow on Bernanke’s views, gleaned not just from his statements as chairman, but from his work as a finance academic. Harris explains why Bernanke favors a formal inflation target -- and why the Fed’s new system of announcements comes close to being just that.

He discusses the chairman’s scholarly interest in the Great Depression, and in the lessons to be drawn from Japan’s restaging of that calamity.

The book examines the chairman’s preference for openness and for more equal participation of other governors and Federal Open Market Committee members in decisions -- a departure from the Greenspan years. There is further discussion of bubbles, of how to deal with risks that lie outside the central-case forecast, and more.

Harris rates the chairman -- barely two years in -- as good overall but weaker than expected on communication.

Some critics attacked Bernanke for being too quick to cut interest rates, and others for being too slow. Yes, says Harris, the Fed was slow to realize the scale of what was happening -- but so were most others.

The author, a forecaster himself, finds it easy to forgive the Fed for being taken by surprise by “the novel nature of the financial crisis.” As for the opposite charge of cutting rates too much, the test of that is inflation expectations, and especially wages: for the moment, no great worries on that score.

Bernanke’s communications glitches -- periodically he has led Wall Street to expect one thing, then done another -- may seem odd for a chairman intent on being more open.

Harris partly blames the markets, accustomed to peering through Greenspan’s fog of obfuscation and unused to taking statements at face value.

But he also touches on another problem, which is something to watch out for in the future. A more democratic Federal Open Market Committee, something else the chairman favors, may be a less predictable one.

When Greenspan spoke, nobody knew what he meant -- but at least he spoke for the Fed. Bernanke speaks good English, but is not so much in charge.

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Clive Crook is a columnist for the Financial Times of London, in which this review first appeared.