EVENTS

Date:	Tuesday, January 24, 2006
Time:	10:00 AM -- 11:30 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

January 2006

What Will Greenspan's Departure Mean?

On January 31, Alan Greenspan will chair his last Federal Open Market Committee meeting. As Council of Economic Advisers chairman Ben Bernanke takes over Greenspan’s position, the economy faces a number of vexing challenges, such as high oil and real estate prices, and the large U.S. fiscal and trade deficits. Will Federal Reserve policy change under Bernanke, or has the Greenspan approach been hard-wired into the Fed? A panel of experts considered these issues at a January 24 panel discussion.

Charles W. Calomiris
AEI and Columbia University

The transition out of the Alan Greenspan era and into the Ben Bernanke one offers an opportunity to reduce the political influences on the Federal Reserve that are likely to increase going forward. Bernanke is coming in at a particularly challenging time. Even though the economy is quite robust and should be in the near future, inflation seems to be trending upward with core inflation possibly reaching 3 percent next year. Therefore, the Fed will need to be aggressive and continue to increase interest rates during the first few meetings of Bernanke’s term. The Fed will also face long-term pressure to revise its definition of what constitutes price stability in order to accommodate the tens of millions of dollars of future Medicare expenses.

These political pressures dealing with monetary policy are commonly analyzed by Fed observers. Yet, the often overlooked regulatory side of the Fed has also become deeply politicized. The Fed has traditionally used its regulatory powers as a political tool to preserve its independence in monetary policy, which is its primary objective. However, there were significant changes that took place in 1999 that increased the Fed’s decision-making authority and political clout. This has exposed the Fed to not just political benefits, but political costs as well.

Even in the 1990s under Chairman Greenspan, there were a few cases of bad regulatory advocacy, and that was during a period in which big banking interests like interstate branching were usually aligned with the best interests of the country. It is unlikely these mutually beneficial interests will continue into the future, and we should not depend on the Fed to solve the political problems when they do arise.

Therefore, I am advocating two policies to depoliticize the Fed. The first is to have Congress make it clear that price stability is the primary objective of monetary policy and to protect the chairman that prioritizes price stability over political pressure. The second is to remove the regulatory powers from the Fed. There has been a large worldwide movement to depoliticize banking regulation by separating regulatory and monetary functions, and the United States would be well-advised to join.

Lawrence B. Lindsey
AEI and the Lindsey Group

I agree that Ben Bernanke will have a difficult transition after replacing Chairman Greenspan. In any company it is difficult to replace a successful CEO that has been there for eighteen years, and the situation here is no different. To complicate things even further, the market conditions are shifting since we are probably at the end of a period of sustained 25 basis point rate hikes.

Currently we have a Federal Open Market Committee (FOMC) whose members hold Alan Greenspan in high regard. It is very likely that their respect for the chairman has somewhat muted their opinions on monetary policy. That means that when Bernanke replaces Greenspan, we will have a group of board members that will feel much more comfortable expressing their opinions than in the past. Therefore, it is probable that members will be speaking from different points of view. In addition, observers will be searching for every nuance in everything that the FOMC members say in the hope of discovering clues about future Fed policy. I think that this excess transparency will lead to volatility and confusion in the markets. Bernanke will surely struggle to establish some form of discipline, especially since the Fed will not actually have an official meeting for two months after Greenspan’s departure on January 31.

What should we expect from Bernanke when facing these challenges? I think he needs to speak clearly to the markets and also establish a consistent vision of the Fed that dictates hawkishness.

Kevin A. Hassett
AEI

I would like to spend my time speaking about my perspective from inside the Fed and about how the mechanics from within the Fed relate to the arrival of Bernanke as the new chairman. The problem is that Congress loves to browbeat the Fed. Especially during election time, members of Congress want to report a raging economy with very low unemployment. But low employment is not always the primary goal of the Fed, which also takes inflation and long-term growth into consideration. Greenspan was able to avoid much of the pressure for short-term economic gain due to his stature, but Bernanke has not yet established the credibility that Greenspan did. Until he does, he must make sure to maintain the long-term monetary goals of the Fed without caving into political pressure.

Why has Greenspan achieved the supreme status that he has? I would argue that one of the main reasons Greenspan is viewed as being the person who knows the most can be attributed to the staff of approximately 200 PhD economists who were able to deliver the best answers that economic science had to offer in a relatively short period of time. I am very confident that the organization that Bernanke is inheriting will be able to deliver the same high-quality research to him, which should result in Bernanke establishing the credibility of his predecessor. It is also likely that Bernanke will benefit from the same underlying strong economy that was seen during Greenspan’s tenure.

AEI intern Paul Stewart prepared this summary.