My Theory on Ben Bernanke

So Ben Bernanke, the Fed chairman, on Friday explicitly justified the logic for another round of quantitative easing (or “QE2”) to salvage our sputtering economic recovery.

On one level, what’s striking about Bernanke’s speech at a conference of the Boston Fed is how textured, detailed and unambiguous it is in trying to explain a decision the Fed won’t officially make until at least Nov. 3. Bernanke acknowledges that consumer spending has been inhibited by a “painfully slow” recovery, that job growth is too slow to make any real dent in unemployment through the end of next year and that inflation is actually running unemployment is coming down too slowly and that inflation is “too low” for the Fed’s comfort. Then Bernanke spells out the implications for monetary policy, with the bottom line being that the time is right for QE2.

For market participants, there wasn’t much here that Fed officials haven’t telegraphed in previous recent speeches. But it’s worth pausing a moment to remember how far we have come from the days when William Greider wrote Secrets of the Temple, the first real expose of the Fed. Back in those days, the late ’70s, the Fed really was a secret temple that disclosed almost nothing about its deliberations, its votes, its decisions or its plans. Alan Greenspan, though no fan of openness, nonetheless presided over a huge expansion of transparency. But Bernanke has taken that much further, and he should get credit. I cannot remember a Fed chairman’s speech that explained an upcoming Fed decision as carefully or as thoughtfully as Bernanke did on Friday. It might be a bit plodding, but the speech marks a landmark in real-time public discussion of central bank policy.

That said, one has to ask: what took Bernanke so long to reach this decision. At the end of the day, his rationale boils down to something that critics — even laymen like me — have been saying and writing for months: unemployment is higher than the Fed wants and inflation is lower than the Fed wants, so there is no good reason for not easing policy further.

One explanation is politics. Fed governors and regional Fed presidents have been split between hawks and doves, and the Fed likes to maintain as much consensus as possible. But I think there’s a more basic reason: Bernanke has been worried that another round of easing might not accomplish much. And he has good reason to worry. Spectacularly low interest rates have done little to spark demand, as evidenced by the massive volume of excessive reserves that banks are parking at the Fed. I think Fed officials are worried that they will be seen as powerless, that they have run out of tricks and that the central bank’s authority and mystique will suffer a long-term blow.

If that’s the case, it’s a bad reason. Bernanke was brilliantly bold in his initial responses to the financial crisis and the downturn. But he lost his nerve more recently, and held back when he should have forged ahead.