Democracy Comes to the Fed

by: Judith Levy

Excerpt from our One Page Annotated Wall Street Journal Summary (receive it by email every morning by signing up here):

New Fed Chairman Hopes to Downplay Impact of His Words

  • Summary: Federal Reserve Chairman Ben Bernanke, who took over from Alan Greenspan last February, has brought democracy to the Fed's decision-making -- an approach the markets are still learning to interpret. Where Greenspan and predecessor Paul Volcker were noted for their ex cathedra pronouncements -- an approach that gave their every word the power to affect the market -- Bernanke encourages the contribution of other Fed officials in matters of policy. Some argue that the Fed does not need much alteration, since Greenspan left it with "strong growth, low inflation, and a near-sterling reputation". But Bernanke's approach -- which entails providing the public with clear, frequent reports of the Fed's goals and forecasts -- could be beneficial. A clear indication of the Fed's goals for the inflation rate, for example, should contain public pressure for higher wages, which would in turn curtail the Fed's need to use "wrenching" interest rate changes to maintain stability. Forecasts on growth, unemployment and inflation would also enable the markets to anticipate whatever interest-rate action the Fed might take, thus rendering them less vulnerable to the specific language used in Fed statements. The danger is that the Fed might be wrong once too often, undermining its credibility, or that the public might find more information confusing rather than illuminating. While some argue that a decentralized, democratic Fed "isn't compatible with the strong leadership the world expects from the U.S. central bank", others hold that the benevolent-dictator approach of Volcker and Greenspan placed too much power in the hands of one person. In the early days of Bernanke's tenure, the markets were oversensitive to his language and misinterpreted him on occasion, but market confidence in him appears to be gaining.
  • Comment: In June, fund manager John Hussman stated that Bernanke's words do not -- and should not -- directly affect the markets.