An old boss of mine, who is well versed in the ways of Washington, once cynically explained to me that in Washington nothing succeeded so well as failure. President Obama's decision to reappoint Ben Bernanke for a second term as Federal Reserve chairman would suggest that my former boss continues to be right about the way Washington works. Despite Bernanke's many egregious errors of judgment during his first term, which have cost the nation so dearly, President Obama is choosing to give him a second chance. And the president is doing so at the very time that the Federal Reserve will be facing extraordinarily difficult challenges of meeting its twin goals of maintaining price stability and promoting economic growth, which will require the exercise of the soundest degree of judgment.
In deciding to stick with Ben Bernanke, President Obama is exercising the most selective of memories. Indeed, the president is choosing to remember only Bernanke's valiant role over the past nine months in pulling the economy from the brink and from preventing the country's worst economic and financial crisis from morphing into a second Great Depression. What the president is blithely choosing to forget, however, is the role that Bernanke might have played during his first two years as chairman in creating the very economic and financial conditions that got us into the mess in the first place. He is also choosing to forget Bernanke's role in the Lehman Brothers debacle that was the trigger for the Great Panic of 2008.
Being charitable, President Obama's decision to reappoint Bernanke is perhaps understandable given how Bernanke's aggressive and innovative policy response helped prevent our financial system from literally imploding following the Lehman bankruptcy debacle last fall. It is also perhaps understandable given how relatively well Bernanke has performed during President Obama's short term in office this year in calming financial markets and in helping to lay the basis for a sustainable economic recovery.
However, in a more sober state of mind, what is difficult to understand is why at the very time that the Federal Reserve is going to need the most judicious of leaderships, President Obama is choosing to turn a blind eye to Bernanke's all too many errors of judgment in 2006 and 2007. The president is choosing to forget that it was on Bernanke's watch as Fed chairman that the worst of the subprime mortgage lending was made and that the worst excesses of the housing market and credit market bubbles occurred without as much as an expression of concern from the Fed. The president is also choosing to forget how slow Bernanke was to comprehend the seriousness of the bursting of the housing market bubble and how slow he was to start cutting interest rates to provide much-needed support to the economy.
If there is anything that one can be sure of about the country's economic future, it is that Ben Bernanke's second term will be among the most challenging for the Federal Reserve in its 100-year history. To arrive at this judgment, all one need do is look at the extraordinary expansion in the Fed's balance sheet over the past 18 months and consider the vast amounts of liquidity creation that this expansion has entailed. In the short space of 18 months, the Fed has more than doubled the size of its balance sheet from around $800 billion at the start of 2007 to over $2 trillion at present, something that has never remotely occurred before in the Fed's long history.
Bernanke's main challenge during his second term will be to prevent the Fed's massive injection of liquidity into the financial system from leading to an unwelcome bout of inflation. Exiting from the Fed's recent massive monetary policy easing will require the most careful exercise of judgment as to timing. If the Fed moves too soon to mop up liquidity and raise interest rates, it will risk aborting the incipient economic recovery. If the Fed moves too little and too late, as seems more likely, it risks letting the inflation genie out of the bottle. If our sad experience with inflation in the 1980s is anything by which to go, this could prove to be disastrous for the country, especially at a time of fiscal profligacy.
In a country of 300 million people, one would have thought that President Obama could have found someone other than Bernanke with his track record of poor judgment to lead the Fed at this delicate juncture. However, now that the president has made his decision, one can only hope that the gods smile favorably on Bernanke and that his second term in office proves decidedly more successful than his first.
Desmond Lachman is a resident fellow at AEI.