The Fed vs. the Financiers

In his August 31 address to the world’s most influential annual monetary policy conference in Jackson Hole, Wyoming, United States Federal Reserve Chairman Ben Bernanke coolly explained why the Fed is determined to resist pressure to stabilize swooning equity and housing prices. Bernanke’s principled position – echoed by European Central Bank head Jean Claude Trichet and Bank of England head Mervyn King – has set off a storm in markets, accustomed to the attentive pampering lavished on them by Bernanke’s predecessor, Alan Greenspan.

This is certainly high-stakes poker, with huge sums hanging in the balance in the $170 trillion global financial market. Investors, who viewed Greenspan as a warm security blanket, now lavish him with fat six-figure speaking fees. But who is right, Bernanke or Greenspan? Central bankers or markets?

A bit of intellectual history is helpful in putting today’s debate in context. Bernanke, who took over at the Fed in 2006, launched his policy career in 1999 with a brilliant paper presented to the same Jackson Hole conference. As an academic, Bernanke argued that central banks should be wary of second-guessing massive global securities markets. They should ignore fluctuations in equity and housing prices, unless there is clear and compelling evidence of dangerous feedback into output and inflation.

Greenspan listened patiently and quietly to Bernanke’s logic. But Greenspan’s memoirs, to be published later this month, will no doubt strongly defend his famous decisions to bail out financial markets with sharp interest rate cuts in 1987, 1998, and 2001, arguing that the world might have fallen apart otherwise.