Bernanke on perilous ground for Fed chairman

[November 20, 2010]  WASHINGTON (AP) -- Federal Reserve Chairman Ben Bernanke is taking some highly unusual steps to counter widespread opposition to his $600 billion plan to jump-start the economy. He's pressing China to let its currency rise and pushing Congress to pass more stimulus aid.

Yet as he veers into these political debates, Bernanke may be putting at risk the Fed's strongest tools -- its credibility and independence.

Bernanke has been under fire since Nov. 3, when the Fed announced a bold plan to buy $600 billion in Treasury bonds. The bond purchases are intended to lower long-term interest rates, lift stock prices and encourage higher spending to energize the weak economy.

In rat-a-tat fashion, critics have attacked the Fed's program. They've warned that the bond purchases will eventually ignite inflation or a wave of speculative buying on Wall Street. China, Germany and other countries have labeled the bond purchases a scheme to drive down the dollar and give U.S. exporters an unfair price advantage. A lower dollar makes U.S. products cheaper for foreign buyers.

Bernanke has struck back in unusually blunt style for a Fed chairman. In a speech at a banking conference in Frankfurt, Germany, he made his most forceful case to date that high unemployment and slow growth, not inflation, are the biggest risks to the U.S. economy. He also accused China and other emerging nations of endangering the global economy by keeping their own currencies artificially low.

Critics see Bernanke's ventures into congressional and global policymaking as a sign of weakness, not strength. If he were confident the Fed's polices were either succeeding or enjoyed support, Bernanke wouldn't feel compelled to try to sell them publicly.

"He needs help, and he doesn't think he's getting it," Dan Greenhaus, chief economic strategist at Miller Tabak, wrote in a research report published Friday.

In pressing Congress and the Chinese to change policy, Bernanke is barging into the political arena, taking on issues like currency valuations that are normally handled by the treasury secretary, a political appointee.

He also risks endangering the Fed's reputation for independence. The Fed needs its credibility to make unpopular decisions, such as raising interest rates to fight inflation, without being smeared as politically motivated.

Allan Meltzer, a professor at Carnegie-Mellon University and author of a history of the Fed, argues that Bernanke has already compromised the Fed's independence. Meltzer said that happened during the 2008 financial crisis, when the Fed bailed out insurance giant American International Group and supported JPMorgan Chase's takeover of troubled investment house Bear Stearns.

"He has acted as the agent of the Treasury Department," Meltzer said. He argues that Bernanke's latest counterattack is another sign of a politicized Fed.

Bernanke is hardly the first Fed chairman to come under fire. When Paul Volcker ran the Fed in the 1980s, he ratcheted up interest rates to levels not seen since the Civil War to bring soaring inflation under control. The Fed's key interest rate rose as high as 20 percent. Today it is near zero.

Volcker endured a barrage of attacks as the economy slowed and unemployment climbed. Angry building contractors shipped two-by-fours to his office. Protesting farmers drove tractors in front of the Fed's stately headquarters in downtown Washington.

So angered by a Fed rate increase, President Lyndon Johnson ordered staffers to find a replacement for Chairman William McChesney Martin. Johnson thought the Fed's policies would make it too expensive to expand social programs and fight the Vietnam War. Martin refused to change course. In the end, he became the longest-serving Fed chairman ever.

"The Fed is criticized all the time," Meltzer said. "If you are making policy, you are going to have critics."

What's different this time is that a Fed chairman has struck back at both Congress and other countries in a highly public manner. After being pounded by Republican lawmakers over the bond-purchase plan, Bernanke -- a Republican himself -- shifted the focus. He urged Congress to step up stimulus if lawmakers hope to bring relief to vast numbers of unemployed Americans.

"It is certainly unusual," Meltzer said. "Bernanke criticizing Congress in the way he did is extreme."

Meltzer thinks Bernanke's counterpunch against China was wrongheaded. "The best way for China to do nothing with its exchange rate is by telling them that it is something the United States wants," Meltzer said.

But Alan Blinder, former Fed vice chairman and professor of economics at Princeton University, says Bernanke was right to "engage the intellectual arguments" of critics at home and abroad.

"I don't think he wants to get into a shouting match with any member of Congress or the finance minister of Germany," Blinder said.

Blinder said he worries, though, that the political backlash might discourage the Fed from taking other steps to try to salvage the economy.

Rep. Mike Pence of Indiana and Sen. Bob Corker of Tennessee, both Republicans, are pushing legislation to narrow the Fed's mission to focus solely on inflation. The Fed has traditionally managed a dual mandate to keep both inflation and unemployment low.

Joseph Gagnon, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics, said he doubts the effort will go anywhere.

"This is more about playing to the peanut gallery in the Republican party than actually doing anything," he said.

The Fed dodged a bigger threat to its independence earlier this year when Congress overhauled regulation of the financial system. Some lawmakers wanted to strip the central bank of its authority to regulate the banking system, saying lax regulation from the Fed contributed to the financial crisis. In the end, the Fed retained most of its power.

Stanford University's John Taylor, a critic of the Fed's handling of the financial crisis and recession, said there's nothing wrong with Bernanke's going public to explain his policies. But past chairmen have tended to speak obscurely and infrequently.

"Too much talking and explaining has diminishing returns," Taylor said. "It tends to muddy the waters."

But Sherry Cooper, chief economist at BMO Financial Group, said the Fed chief sent an unmistakable message to his critics: "Bernanke is nobody's punching bag."

[Associated Press; By PAUL WISEMAN and JEANNINE AVERSA]

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