By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
It has been almost a week since the Bernanke testimony and since the dust has settled, two exchanges stand out in my mind. They are not the most incendiary moments or the most vitriolic remarks; however, I believe that Bernanke’s answers say a great deal about the Fed.
Bernanke Grades the Fed on a Curve and Awards It a Pass
Early in the testimony, Senator Shelby asked Bernanke whether or not he (Bernanke) thinks the Fed did a satisfactory job of supervising and regulating financial institutions prior to the crisis. (I do not remember the exact words.) Bernanke responded: “We didn’t do a perfect job by any means, but I don’t think we stand out as having done a worse job than other regulators.” While confession maybe good for the soul, I do not think that Bernanke did the Fed a favor with that response. Given the SEC’s performance, the phrase “damning with faint praise” comes to mind.
At a later point in the testimony, Bernanke pointed out that many of institutions and instruments at the heart of the crisis were not the direct responsibility of the Fed. Still, if the Fed cannot make positive arguments for retaining supervisory/regulatory responsibilities, then the odds of the Fed retaining a supervisory role just dropped.
Bernanke Avoids a Domestic Political Problem by Exacerbating an International Policy Problem
At one point, Bernanke was asked if the low interest rates were fueling price bubbles in commodities and other asset prices here and abroad. The WSJ reports his response as follows:
The Fed chief said near-zero interest rates were not fueling asset price bubbles in the US and that it was not the Fed’s job to prevent bubbles abroad. “US monetary policy is intended to address both financial and economic issues in the US,” he said. “Countries that are concerned about that have their own tools to address bubbles in their own countries.”
This was the answer that the Senators wanted to hear, but it will not be without negative consequences — the veracity of the statement that policy is not fueling asset bubbles domestically aside. When US officials suggest/request that other countries change their exchange rate policies to help correct the US trade deficit, who do you think their foreign counterparties will quote? The already low chances for a cooperative unwinding of the global imbalances got lower.
Bernanke is not just the head of an important central bank. He is the head of the central bank that issues the world’s reserve currency. For decades, the US has benefitted from the Dollar’s reserve status, e.g., lower interest rates and lower inflation and exchange rate volatility. Now, Bernanke asserts that it was all a free lunch. Reserve status imposes no responsibility on the US, which is free to set policy that will contribute to trade deficits and lead to the depreciation of the Dollar (and the value of Dollar reserves) in terms of other currencies as well as in terms of commodities.
Furthermore, in the past, many countries that currently hold Dollar reserves experienced problems arising from external imbalances. In exchange for international help, they were required to adopt a range of policies including fiscal and monetary austerity, exchange rate depreciation as well as financial market restructurings while surplus countries were not required to adjust their policies. The policy mix was referred to as the “Washington consensus”, as the driving forces behind the arrangements were the IMF and the US Treasury. Now they will see the US as requiring them to adjust policies so that the US can avoid any domestic adjustments, even though the US has fiscal and external imbalances and was the epicenter of the financial crisis.
US standing in the world fell when Washington assumed that everyone shared “American” values. The US standing will fall even faster if Washington expects other countries to surrender policy freedom and experience lower rates of growth so that the US can run policies of its choosing while pursuing economic growth.