Bernanke and the Bubble

By PAUL KRUGMAN

By Bush administration standards, the choice of Ben Bernanke to succeed Alan Greenspan as chairman of the Federal Reserve was just weird.

For one thing, Mr. Bernanke is actually an expert in monetary policy, as opposed to, say, Arabian horses.

Beyond that, Mr. Bernanke's partisanship, if it exists, is so low-key that his co-author on a textbook didn't know he was a registered Republican. The academic work on which his professional reputation rests is apolitical. Moreover, that work is all about how the Fed can influence demand - there's not a hint in his work of support for the right-wing supply-side doctrine.

Nor is he a laissez-faire purist who believes that government governs best when it governs least. On the contrary, he's a policy activist who advocates aggressive government moves to jump-start stalled economies.

For example, a few years back Mr. Bernanke called on Japan to show "Rooseveltian resolve" in fighting its long slump. He even supported a proposal by yours truly that the Bank of Japan try to get Japan's economy moving by, among other things, announcing its intention to push inflation up to 3 or 4 percent per year.

Last but not least, Mr. Bernanke has no personal ties to the Bush family. It's hard to imagine him doing something indictable to support his masters. It's even hard to imagine him doing what Mr. Greenspan did: throwing his prestige as Fed chairman behind irresponsible tax cuts.

All of this raises a frightening prospect. Has President Bush been so damaged by scandals and public disapproval that he has no choice but to appoint qualified, principled people to important positions?

O.K., seriously, many economists and investors feared that Mr. Bush would try to place a highly partisan figure in charge of the Fed. And even before the revelations surfaced about cronyism at FEMA and elsewhere, there was widespread concern that Mr. Bush would try to select a John Snow type - a businessman whose only qualification is loyalty - to run monetary policy. The naming of Mr. Bernanke was a sign of Mr. Bush's weakness, and it brought a collective sigh of relief.

Obviously I'm pleased, too. Full disclosure: Mr. Bernanke was chairman of the Princeton economics department before moving to Washington, and he made the job offer that brought me to Princeton.

So should we all feel confident about the economic future, assuming that Mr. Bernanke is confirmed? Alas, no.

This isn't a comment on Mr. Bernanke's qualifications, although there is one talent, important in a Fed chairman, that Mr. Bernanke has yet to demonstrate (though he may have it). Mr. Greenspan, for all his flaws, has repeatedly shown his ability to divine from fragmentary and sometimes contradictory data which way the economic wind is blowing. As an academic, Mr. Bernanke never had the occasion to make that kind of judgment. We'll just have to see whether he can develop an economic weather sense on the job.

No, my main concern is that the economy may well face a day of reckoning soon after Mr. Bernanke takes office. And while he is surely the best politically possible man for the job (all the other candidates I would have been happy with are independents or Democrats), coping with that day of reckoning without some nasty shocks may be beyond anyone's talents.

The fact is that the U.S. economy's growth over the past few years has depended on two unsustainable trends: a huge surge in house prices and a vast inflow of funds from Asia. Sooner or later, both trends will end, possibly abruptly.

It's true that Mr. Bernanke has given speeches suggesting both that a "global savings glut" will continue to provide the United States with lots of capital inflows, and that housing prices don't reflect a bubble. Well, soothing words are expected from a Fed chairman. He must know that he may be wrong.

If he is, the U.S. economy will find itself in need of the "Rooseveltian resolve" Mr. Bernanke advocated for Japan. We can safely predict that Mr. Bernanke will show that resolve. In fact, Bill Gross of the giant bond fund Pimco has already predicted that next year Mr. Bernanke will start cutting interest rates.

But that may not be enough. When all is said and done, the Fed controls only one thing: the short-term interest rate. And it will be a long time before we have competent, public-spirited people controlling taxes, spending and other instruments of economic policy.

Copyright 2005 The New York Times Company