StreetTalk: Transition at the Fed: From Greenspan to Bernanke

When former Federal Reserve chairman Alan Greenspan's term in office expired on January 31, 2006, many people said, "There goes a legend." Maybe the better expression was, "Here comes the spin."

The conventional belief was that Greenspan ran the nation's economy like a true cultural icon. Supposedly, he was an economic Merlin who assured prosperity by astute reading of the economic tea leaves and subtle policy adjustments. For 18 years, longer than any of his predecessors, he led the US Federal Reserve Bank (The Fed) very much in his own image—strong, deliberate, intelligent, and responding to the needs and desires of his time.

Brian O'Connell

Some see it differently. Ravi Batra, author of the myth-bashing book "Greenspan's Fraud" (Palgrave Macmillan, New York, 2005) says that the "real impact" of Greenspan's term was akin to a high-explosive detonation.

A proponent of "rational selfishness" and a disciple of Ayn Rand, Greenspan "unwittingly effected a global crash and spread economic misery on our planet," writes Batra. "Duplicity underlies his actions. Whether it is Social Security, taxes, industrial deregulation, or financial markets, Greenspan sways it all."

Batra accuses Greenspan of profiting from his own tax policies, engineering through his economic policies the dot-com bubble and subsequent recession, and sending millions of Americans into poverty.

Whatever one thinks of Greenspan, he's history. That became official on February 1, when Ben Bernanke was sworn in as his replacement. The people on Wall Street and Main Street, who revered Greenspan for almost two decades, began speculating on how the new chief would perform.

That's important—not just to the life sciences industry, but to investors everywhere. The Fed is crucial to the US economy; part gatekeeper and part financial manipulator. The Federal Reserve is the bank of the US government and, as such, regulates all US financial institutions. Many have deep investment interests in the biopharm industry. One utterance from Ben Bernanke and the stock prices of Merck or Roche could plummet within minutes. The new Fed chair found that out the hard way when some cocktail party comments on inflation and interest rates to CNBC reporter Maria Bartiromo went to her audience the next morning, sending the stock market into a steep dive.

Past that glitch, Bernanke seems to be operating on an even keel, albeit steering a vessel across stormy economic seas.

Consider that, in its first 100 or so days, Bernanke's Fed has had to grapple with a record $800 billion trade account deficit, a $319 billion budget deficit, and a population that has virtually stopped saving but loves borrowing.

Bernanke's been focused on addressing these and other issues during his first few months—setting sound monetary policy that's heavy on growth and low on inflation. Unlike Greenspan, however, he has some very different notions for achieving it.

The centerpiece of his plan is creating a transparent Federal Reserve, an approach contrary to how Greenspan steered the ship. Still, Bernanke is steadfast in his belief that the Fed should make its moves abundantly clear to stakeholders, stay focused on finances and interest rates instead of debts and deficits, and speak a language that the markets can understand without the need of a translator.

"Fresh air," Bernanke's quoted as saying, "is good for the Federal Reserve." And the best way he sees to achieve it involves:

• Setting inflation targets.

• Leaving politics up to the politicians.

• Depersonalizing monetary policy.

• Communicating as clearly as possible about the Fed's intentions.

Greenspan and Bernanke both recognize the central bank's need to recalibrate its money strategy and maintain a low and stable rate of inflation. It's their philosophies for doing so, however, that are distinctly different.

Inflation Targeting

"Where [Bernanke] differs from Greenspan is that he is more in favor of explicitly putting a rule on monetary policy," says Victor Zarnowitz, a retired University of Chicago economist who now works at the Conference Board in New York City.

That rule involves what economists call "inflation targeting," a practice that has been embraced in other countries. It involves setting a public target for inflation, preferably between one and three percent based on the Consumer Price Index. This target is then used as a benchmark against which the central bank can be accountable.

Proponents of such targets, like Bernanke, view them as good for helping the Fed identify when it's time to clamp down on inflation (i.e., if rates exceed the designated range). They also see targets as a means for:

• Providing greater confidence to investors in stocks, bonds, currency, and commodity markets, as they help clarify just where interest rates are headed.

• Reining in expectations. After all, European countries that have adopted inflation targeting have successfully controlled inflation without sending markets into sharp gyrations.

• Managing unemployment and inflation, and controlling the growth of the money supply by signaling when to adjust interest rates.

• Building support for the Fed's actions. "The more guidance a central bank can provide to the public about how policy is likely to evolve," Bernanke said in 2004, "the greater the chance that market participants will make the appropriate inferences."

Opponents of inflation targets, have typically shied away from using them as a motivator. "Greenspan would [prefer to] rely on judgment, which in his case, depends so much on the judgment of a single man," says Zarnowitz. And, in fact, Greenspan has publicly expressed his reluctance in using targets, in favor of a more discretionary approach.

Critics worry that once you quantify an objective publicly, you become more accountable for it, and in the process, shift public attention to it, diminishing the visibility and viability of other important policies and initiatives.

No one knows how the market might react to publicly announced inflation targets. "The markets would have to learn," says Michael Levy, chief economist at Bank of America. He adds that because Bernanke's written extensively on inflation targets, his credibility and expertise on the topic will help to bring investors along.

Looking ahead, experts say that Bernanke's greatest challenge will be leading the Fed to act as a central bank for the world. This is something that Greenspan tried to embrace, despite the discomfort of some traditional economists. They argue that the Fed's primary mandate is to promote full employment and price stability at home.

Still, it's becoming increasingly obvious that achieving this domestic mandate is the best way to contribute to the economic stability of the world. Due to economic and financial integration it is becoming difficult for any government agency to compartmentalize itself and its policies.

Greenspan had his moments. He understood the importance of the world in setting monetary policy and participated by promoting cooperative research and solutions to common global policies (i.e., ranging from the Y2K transition and the aftermath of 9/11). His administration did it the careful way, choosing to be selective about the initiatives it undertook; engaging in international economic and financial issues only when they became too important to ignore.

Now, with Bernanke at the helm, it remains to be seen how he'll address these things. The betting here is that he will take a proactive approach in managing international financial affairs and transforming banks into global institutions—as well as cultivating the public's confidence in a central banking system that recognizes the need for growth and risk-taking that have come to define the life sciences market. Here's hoping Big Ben is up to the task.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek, 79 Radcliffe Drive, Doylestown, PA 18901, 267.880.3144, fax 267.880.1939, brian.oco@verizon.net