ALAN GREENSPAN, the outgoing chairman of the Federal Reserve Board, will be remembered as the man who shifted the global balance of power even more decisively in favour of America and away from Europe by proving that it was possible for a central bank to limit unemployment, regulate economic growth and control inflation, all at the same time.
Many European policymakers, remaining true believers in the monetarist doctrines of the German Bundesbank, which always insisted that the one responsibility of a central bank was to control inflation, have regarded the politically conservative Greenspan with the fear and loathing reserved for apostates and traitors to monetarist cause. Mention Greenspan’s success in steering the US economy through the 17 years of global turmoil and you always get the same response: “Yes, America is doing well so far, but before drawing any conclusions let us wait for the last chapter of the Greenspan story.”
Well, with Greenspan due to be replaced in three months by Ben Bernanke, the last chapter of the Greenspan saga is finally at the printers and after last Tuesday’s quarter-point increase in US interest rates we know more or less exactly what it will say. Monetary policy will continue to be tightened slowly but surely until the meeting of the Federal Open Market Committee on January 31, the day of Greenspan’s resignation, by which time interest rates will stand at 4.5 per cent. The US economy will inevitably slow from its present unsustainably rapid 3.5 to 4 per cent growth rate and inflation, which recently has been showing disconcerting signs of acceleration, will again become the Fed’s primary preoccupation, after a five-year period when the central bank has mostly devoted itself to increasing employment and accelerating growth.
Will Bernanke carry on with Greenspan’s controversial attempts to follow the Fed’s “dual mandate” of managing both employment and inflation? Or will he revert to the true religion of monetarism, which insists that central bankers should focus only on inflation and never be distracted by efforts to stabilise the business cycles and foster economic growth? To judge by his published articles and speeches, Ben Bernanke is going to be every bit as ambitious as Greenspan in his efforts to sustain the growth of US economic activity and employment. And as a fully fledged academic economist, which Greenspan never claimed to be, he will be even more aggressive in his theoretical rejection of Bundesbank-style monetarist orthodoxy, which insists that central bankers should focus only on inflation, leaving employment and demand growth to the tender mercies of Says Law (the early 19th century dictum that supply creates its own demand).
Bernanke’s ultra-activist views on monetary policy and the central bank’s responsibility for maintaining the balance between supply and demand have emerged in three strands of his recent work: his discussions of inflation targeting, of asset bubbles and of imbalances in global trade. In each case, the new man has gone even farther than Greenspan to defy the classic monetarist prescriptions that used to be fashionable among academic economists in the 1980s and still dominate the thinking of European governments and central banks.
Bernanke’s public advocacy of inflation targeting has led some neo-monetarists to hope that he might support a shift away from Greenspan-style discretionary demand management under the Fed’s dual mandate — its legal duty to stabilise both prices and employment — towards a more mechanical policy exclusively focused on controlling inflation. Nothing could be further from the truth. Bernanke has explicitly rejected the idea that central banks should “focus exclusively on control of inflation and ignore output and employment objectives”. In his view, inflation targeting is mainly a device to “anchor” inflationary expectations. When inflation expectations are stable, the Fed can enjoy greater freedom to manage demand and employment according to whatever priorities society may decree. As Bernanke said in his most detailed official discussion of the subject: “Inflation targeting is fully consistent with any set of relative social weights on inflation and unemployment; the approach can be applied equally well by “inflation hawks”, “growth hawks”, and anyone in between. Personally, I subscribe unreservedly to the dual mandate (to stabilise inflation and maximise employment), and I would not be interested in inflation targeting if I didn’t think it was the best available technology for achieving both sets of policy objectives.”
On asset bubbles, Bernanke has bluntly rejected the view that the Fed should try to prevent, deflate or otherwise react to asset bubbles. In his definitive speech on the subject as a Fed governor he said: “The Fed should use monetary policy to target the economy, not asset markets. For the Fed to be an arbiter of security speculation or values is neither desirable nor feasible . . . One might as well try to perform brain surgery with a sledgehammer.”
Turning finally to the US current account deficit and the so-called global “imbalances” allegedly created by the irresponsible policies pursued in the Greenspan era, the new Fed Chairman is even more unorthodox. Bernanke attributes the surge in the US current account mainly to the global demand for US assets, which in turn is a function of a “global savings glut”, mainly created in Asia after the 1997 collapse.
Another major cause of excess saving is weak consumer demand and mortgage borrowing in Europe and Japan. As long as Asia and Europe keep spending less than they earn, the US can continue borrowing and is right to do so. If the Asians and Europeans ever start to spend, the US deficits will shrink of their own accord, without any massive dislocation in either global exchange rates or US economic growth.
And if the US current account declines without a corresponding increase in European spending? Then, the global economic imbalances will certainly be a major problem — but the costs of correcting them will fall entirely on Europe, while the US economy will continue to lead the world.
