October 24, 2005
Bernanke to Replace Greenspan
The President has nominated Ben Bernanke to replace Alan Greenspan on Jan. 31, 2006 as Chairman of the Federal Reserve System (the Fed), subject to confirmation by the Senate. He is extremely accomplished and Senate confirmation should not be difficult. Some are worried that his "inflation-target" philosophy will constrain his willingness to "create jobs." The worries are misplaced. Indeed, his inflation-target theory, if he stays with it, will be a positive development in the leadership of the Fed. ...
At present the market hangs on every word of the Greenspan, attempting to anticipate his interest rate decisions. For traders know that with each interest rate decision comes a stock and bond market reaction. Guess right and you can make some money. Simply put, there is too much discretionary authority in one man to affect significantly the trading markets. Bernanke is on record touting the benefits of a more predictable Fed rate decision procedure. Predictability and market stability would come from a set inflation target, known in advance by all. Rate decisions would be automatic in response to whether inflation was inside our outside the target. If inflation is within a target there would be no rate change; if outside the target the rates would change to bring it back inside the target.
Critics of such an approach want the Chair of the Fed to be a Mr. Fix-it for a declining job market; they want he to "create jobs." This asks the Fed to do to much. The Fed does not create jobs, business does. Moreover, asking the Chairman of the Fed to use short term interest rate stimuli, regardless of its effect on inflation, to spur business growth whenever political winds blow in that direction is a recipe for long-run economic instability. The resulting price instability in the markets will have long-term substantial costs. It is eating the hen that lays the eggs.
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