Why Bernanke Might Have Told Obama: Thanks, But No Thanks For Second Term
Federal Reserve Chairman Ben Bernanke accepted President Obama’s nomination late last month for a second term and will undergo confirmation hearings this fall.
But based on history and what Bernanke may be facing during his next four years, he may have been better off to politely decline the president’s offer.
For Fed chairmen, decisions made during the first term often come home to roost during a second term, bringing with them harsh criticism. Even though the Fed chairmanship is theoretically an independent office, it is subject to political pressures from the White House and Congress, as politicians follow public opinion polls.
And Fed chairman can even find themselves being blamed for lost elections by presidents who unsuccessfully sought second terms.
Consider the example of William P. G. Harding, second Fed chairman. A key figure in the Fed’s formation, his second term saw the single most deflationary year in U.S. history (1920), when prices dropped 37 percent.
Or Arthur Burns, Fed chairman from 1970-78. The economy grew through almost the entire length of his first term. But almost as soon has his second term started, a 16-month recession took hold.
Or even consider Alan Greenspan. Appointed in 1987, he presided over nearly two decades of strong growth (interrupted by two short recessions, in 1991 and 2001). He retired in 2006 just as U.S. housing prices peaked. Then came the bursting of the housing bubble and all the questions about his leadership. Testifying before Congress last fall, he admitted he made a mistake believing in self-regulating markets.
We called up economist and Fed historian Allan Meltzer at Carnegie Mellon and asked: Is there a difference between a Fed chairman’s first and following terms? Do they feel political pressure? Or do they become more emboldened? And what will Bernanke face in his second term?
“The Fed is an independent agency, but that has a changing meaning,” Meltzer said. “It means different things at different times.”
For instance: William McChesney Martin Jr. was Fed chair for nearly 20 years, from 1951-70. Both Presidents Truman and Eisenhower were deficit hawks and President Kennedy was no fiscal spendthrift, either.
“But then [Martin] ran into President Johnson,” Meltzer said, “who was more interested in his Great Society and the war in Vietnam and ran big deficits. [Martin] had much bigger deficits and he ended up financing them and gave us great inflation.”
Presidential familiarity with a Fed chairman can also compromise his independence.
White House tapes reveal hours of conversation between President Nixon and Burns, when he was chairing the Fed. Nixon had known Burns for more than 20 years, when Burns had sat on Ike’s Council of Economic Advisors and Nixon was vice president.
Nixon wanted more control over the Fed, Meltzer said, and the tapes reveal him stroking and hectoring Burns to make sure he created favorable economic conditions for Nixon’s re-election bid in 1972.
Meltzer recounts: “You’d hear Nixon telling Burns over and over again, ‘You remember, Arthur, you warned me about the 1960 recession. You told me that was going to happen and that cost me the election. You’re not going to let that happen again, are you?’ ”
And after President George H.W. Bush lost his re-election bid in 1992, Meltzer said, he attributed the result to Greenspan. “He wouldn’t ease money during the election, to his credit,” he said.
As for Bernanke’s second term, one might reasonably ask: How could it get any worse than his first term?
But Meltzer had a one-word answer for what lies ahead: “Inflation.”
Despite the fact that Bernanke turned on the money spigot when this economic crises began and printed billions of new dollars, inflation has stayed in check (indeed, the economy is showing signs of deflation) and there is little widespread concern about it coming back, near-term.
However, Meltzer said inflation is inevitable because of the political pressure that will be brought to bear on Bernanke as unemployment hovers around 10 percent, twice its normal rate. He’ll want to raise interest rates from their historically low levels to counter inflation, but he won’t be able to, Meltzer said.
“You’ll have Congress, the labor unions and the public all going to say, ‘We’ve got this high unemployment and you’re going to raise interest rates to 6, 7, 8 percent?” Meltzer said. “That’s a political non-starter.”
When it comes to second terms for Fed chairmen, Bernanke can only hope he ends up as well off as Paul Volcker, who was picked by President Carter to run the Fed in 1979 and reappointed by President Reagan, eventually serving until 1987.
Volcker came in with two goals in mind: beat back inflation, which was driving up prices in the U.S. economy, and somehow get a stagnant economy moving again, following the post-Vietnam contraction and two oil shocks.
Volcker did it. He raised the federal fund rate mercilessly, making money so expensive that prices went down. Inflation fell from 13.5 percent in 1981 to 3.2 percent within two years.
But these moves contributed to a recession and a 10.7 percent unemployment rate. Volcker, hailed as the great conqueror of inflation, found himself pilloried as the author of a downturn and killer of small businesses. His high interest rates were decried by debt-burdened farmers, who even drove their tractors to the Federal Reserve in Washington in protest.
But Reagan, who understood the dangers of inflation and believed in Volcker, reappointed him.
By Volcker’s second term, inflation was whipped, tax cuts helped jump-start the economy and Volcker became something of a folk hero.
Now, Volcker, who turns 82 this weekend, holds a place of special esteem in Obama’s economics brain trust. Bernanke may be happy just to get back to Princeton in one piece.
September 4, 2009; 5:06 PM ET
Categories: The Ticker | Tags: Ben Bernanke, Federal Reserve, Obama, Paul Volcker
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