Global Policy Forum

By Mark Weisbrot*

Ben Bernanke's first promise upon being nominated for Chairman of the U.S. Federal Reserve was that he would "maintain continuity with the policies and policy strategies established during the Greenspan years." Of course he was speaking to the financial markets, which tend to worship Greenspan and are rather jittery about change these days—as anyone sitting on the edge of a cliff and staring down into the abyss might be.

But following in Greenspan's hallowed footsteps might not be so easy, nor would it necessarily be the best thing for the U.S. economy. After all, it was Greenspan who persuaded Congress in January 2001 that President Bush's proposed tax cuts were fiscally responsible, arguing that without them we would pay off the national debt too quickly. Oops! The gross federal debt for the current fiscal year is projected to be the highest in 50 years, at 67.5 percent of our GDP.

Alan Greenspan made some other mistakes that have cost the American people dearly, and others that have yet to come home to roost. After initially warning of "irrational exuberance" in the stock market in December 1996, he reversed himself and allowed the stock market bubble to inflate to unsustainable levels. Millions of Americans lost much of their retirement savings in the ensuing, predictable crash.

When the stock market bubble burst and triggered the recession of 2001, the recovery was fueled by an already established housing bubble that has now created more than $5 trillion of excess wealth. The Greenspan Fed helped this bubble along, too—although recently Mr. Greenspan has started to talk about it. But when this bubble bursts it will almost certainly cause a recession, and we will wish that the Fed had warned the public more clearly —and earlier—about the dangers of over-inflated home values.

Bernanke says that he, like Greenspan, doesn't see bursting asset-market bubbles as the Fed's responsibility. But the Fed chairman testifies regularly on the state of the economy, and the Fed is the major regulator of the country's economic activity. It makes no sense to say that the Fed can warn of the dangers of inflationary pressures, give advice on spending and tax policy and everything under the sun, but must remain silent when a speculative frenzy poses an economy-wide threat to the nation.

The Fed can cool off a bubble without having to raise interest rates and thereby dampen other economic activity. For example, to deal with the housing bubble, all the Fed chairman would need to do is explain the reality: since 1996 house prices nationally have increased more than 45 percentage points after adjusting for inflation. From 1950-1995 house prices increased at the same rate as inflation. It is easy to show that this sharp break with the past is the result of a speculative bubble. If the Fed won't do this, who will?

Bernanke seems less politically aligned than his predecessor, so he is less likely to imitate Greenspan's endorsement of such partisan plans as Social Security privatization. He is qualified for the job. But he is inheriting some serious economic imbalances. In addition to the housing bubble and the near-record levels of federal debt, we have an unsustainable trade deficit and a much overvalued dollar. The interest rate on long-term (10-year) U.S. Treasuries is being held down by Asian central banks' buying them, which could slow any time and drive these rates (which the Fed can't directly control) upward. This would probably pop the housing bubble. And then there is inflation, the Fed's main enemy, which was running at 9.4 percent annually over the last quarter. Ouch. Bernanke will be lucky if he makes it through his first two years and still has a job.

About the Author: Mark Weisbrot is co-director of the Center for Economic and Policy Research.

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