When Ben Bernanke succeeded Alan Greenspan as chairman of America’s Federal Reserve a year ago this week, Wall Street’s commentariat had two questions. Would “Helicopter Ben” prove to be a credible inflation fighter? Many bond traders remembered him as the Fed governor who had once mused about preventing deflation by dropping money from the sky. And at what pace would the former Princeton professor push the Fed towards adopting a formal inflation target, an idea he had long championed? One year on, the answers seem to be “yes” and “slow”.
After a rocky start, Mr Bernanke has won inflation-fighting credentials (see chart at the bottom of the page). Last May was a low point. The new Fed chairman told congressmen that the central bank might pause its interest-rate increases even if inflation was rising. Bond markets took this to mean that a pause was imminent and inflation hawks began to fret. He compounded the mess by confiding to a journalist that the markets had misinterpreted him.
Though serious, that setback proved short-lived and the chairman’s reputation has steadily risen since last summer. That is largely because his judgments have proved correct: notably, to stop tightening in August with rates at 5.25% yet retain a hawkish bias despite the housing recession. Inflationary pressure has abated and, as Mr Bernanke argued, the economy has seemed to shrug off the housing market.
Two months ago financial markets were sure that the Fed, for all its hawkish talk, would soon cut rates. But as the statistics have strengthened, Wall Street has fallen into line with Mr Bernanke. Far from heading for recession, preliminary figures released on January 31st showed output rose at an annual rate of 3.5% in the last three months of 2006, above the economy’s trend pace. On the same day, the Federal Open Market Committee (FOMC), the central bank’s policymaking body, said it was once again holding rates at 5.25%. Although it acknowledged that inflation figures have improved “modestly”, it kept its hawkish bias.
Meanwhile, Wall Street is gradually getting used to the style of the Bernanke Fed, which seems to be more democratic than the Greenspan model. Mr Bernanke has altered the format of the FOMC’s discussions to encourage debate. Don Kohn, the Fed’s vice-chairman, is particularly influential: he gave the speech that has had the biggest impact on the markets in the past six months. Dissent is tolerated: Jeff Lacker, president of the Federal Reserve Bank of Richmond, disagreed with the decision to halt tightening in August and dissented at every subsequent FOMC meeting until his stint as a voting member ended in December.
This collegial approach is one reason why the Fed has moved more slowly towards inflation targeting than many outsiders expected. Although several governors agree that such a target makes sense in principle, they are loth to change a system that seems to be working well. Mr Kohn, a sceptic, is in charge of a special committee to guide the deliberations. It seems in no hurry. Nor are the external circumstances auspicious. With the Fed’s preferred price gauge, the deflator for personal consumption expenditures excluding oil and food, still above the 1-2% that is widely read as an informal goal, the central bankers have not been keen on making a target explicit.
The change of control in Congress has slowed progress too. Democrats are particularly suspicious of inflation targeting, fearing it would compromise the Fed’s other statutory goal, that of maximising employment. Barney Frank, the chairman of the House Financial Services Committee, has grave doubts about the idea.
Internally, rapid turnover has made matters harder. The FOMC is full of new faces. Besides Mr Bernanke, three Fed governors have arrived in the past year and one seat is still vacant. One of the newcomers, Frederic Mishkin, is a well-known advocate of inflation targeting. There is change at the regional reserve banks too. Charles Plosser, a former economics professor, became president of the Philadelphia Fed in August. Jack Guynn retired from the Atlanta Fed in October; his successor has not yet been named. The presidents of the Boston and Chicago Feds, both voting members this year, recently said that they would be stepping down. Though they are far from agreeing to an explicit inflation target, the central bankers are discussing other ways to improve transparency. One option is to release more frequent economic forecasts. The central bank now publishes projections for growth, inflation and unemployment twice a year, based on estimates by board members and regional reserve banks. Possible changes include issuing quarterly forecasts with a more detailed description of the economic outlook. A baby step, perhaps, but in the right direction.