Federal Reserve Chairman Ben S. BernankeThe biggest decision of the economic recovery will be made in the next six months, and Barack Obama will have almost nothing to do with it.
Forget the debate over TARP, and never mind the questions about a second stimulus. This decision is about when to pull out $1 trillion that’s propping up the U.S. banking system. And it will be Federal Reserve Chairman Ben Bernanke and his Fed colleagues who make the call.
That’s hard enough for a White House that knows its political fortunes rise and fall with the economy.
What’s worse is that Bernanke and Obama – like many presidents and Fed chairmen past – won’t necessarily have the same goals for this trillion-dollar decision.
Fed chiefs worry about inflation. Bernanke wants to take the money out quickly enough to prevent the economy from overheating and causing a jump in prices that strangles growth. But move too fast, and the economic recovery runs out of fuel.
Presidents worry about jobs. Obama probably wouldn’t mind a little overheating, say, next summer – when voters are starting to make up their minds about the 2010 congressional elections, and he hopes the economy can shake the 10-percent unemployment rate doldrums.
“Any chairman of the Fed will do what’s right for the country, not what’s right for the administration,” said Ernest Patrikis, a partner at the law firm White & Case who spent 30 years at the New York Fed. “That’s his job – that’s why he’s apolitical.”
“The exit will be so difficult,” said economist Joseph Brusuelas of Moody’s Economy.com. “Bernanke wants to engineer a recovery that does not include inflation. Obama wants a more robust recovery and like many political actors may be willing to forgo a little inflation for a little more employment.”
The White House is already worried that jobs won’t be coming back fast enough next year, Fed or no Fed.
Obama economic adviser Christina Romer warned a congressional panel Thursday that the jobs picture will remain “painfully weak” through 2010, with a seriously elevated unemployment rate for another year.
So all the White House can do is watch and wait, and hope it doesn’t pay a political price for any missteps by Fed officials they can’t control.
“It’s a dicey thing to do, and they know it,” said Sen. Richard Shelby (R-Ala.), the ranking member on the Senate Banking Committee. “They have to be careful.”
The Fed’s moves are shrouded in secrecy, their prerogative to move the levers of the economy closely guarded – so much so that there’s been a recent a rise in populist anger about this all-powerful agency that exists largely outside the democratic process.
But because the Fed is an independent agency, it’s even considered bad form for a president to talk much about it – and indeed, the White House refused to comment for this story.
Last fall, the Fed injected $ 1 trillion-plus into the nation’s banking system – at times, by providing financial institutions with cash to cover their losses as the global meltdown spread. Now Fed officials are already talking about the need to withdraw the funds injected into the economy during the darkest days of the crisis, moves that are credited with largely saving the United States from plummeting into an economic depression.
“Given the highly unusual economic and financial circumstances, judging when the time is appropriate to remove policy accommodation, and then calibrating that removal, will be challenging,” said Federal Reserve Vice Chairman Donald Kohn in a speech to the Cato Institute on Sept. 30. “Still, we need to be ready to take the necessary actions when the time comes, and we will be.”
Translation: “policy accommodation” is the cash, and “the necessary actions” are the decision to ease it out of the economy.”
And is the Fed prepared to the pull the trigger? “We will be” seems to cover it.
Already, the Fed is already showing some signs of restlessness. On Monday, the New York Fed tested its “reverse-repo” process -- one tool the Fed could use to use to pull the money out when the time comes. The test run was widely interpreted as a sign the Fed is getting ready to act – but when, nobody knows.
The Fed can also tap on the brakes at the first sign of inflation by raising interest rates, now near zero. The Fed has said it will keep the rock-bottom rates for an extended period, but it won’t be more specific when they could go up – a decision that is bound to be controversial when it comes.
Patrikis thinks the Fed will make a decision on withdrawing liquidity either during the second quarter of 2010, or after the November elections that year – but that it won’t make any dramatic moves in the run-up to Election Day.
Still, he said, it is too early to predict what the Fed might do. And Patrikis points out that Obama will have indirect input into the decision, because there are two vacancies on the Fed’s board now that Obama will fill in the coming months. The president will surely select board members whose economic judgment he trusts.
Between the two vacancies, a member who Obama appointed earlier this year and Bernanke himself, the president will likely have named four of the seven members of the Fed’s Board of Governors by the time they make the call.
But the Fed knows actions like that can have political consequences. “There are few politicians who like higher interest rates,” said one former Fed official. “And President Obama is a politician.” That said, the official continued, “I suspect they will be broadly on the same page.”
That’s because Obama, too, has a longer-term time frame in mind: 2012, when he will be running for reelection. It’s in Obama’s interest for the Fed to take inflation prevention measures now so that he doesn’t have to run a tricky reelection campaign in a high-inflation environment.
Tensions between Presidents and Fed chairmen are nothing new.
In the 1980s, Fed Chairman Paul Volcker declared war on inflation. His strategy: raising interest rates. Volcker jacked the Fed funds rate to 20 percent, which contributed to the deep early 1980s recession that caused howls of protest from the White House and incumbent Republicans on Capitol Hill. The Fed, grumbled then-Senate Majority Leader Howard Baker (R-Tenn.), should “get its boot off the neck of the economy.”
Nonetheless, Volcker’s strategy worked, and the Fed broke the back of the inflation cycle. Ironically, Volcker is a top economic adviser to Obama today.
In the 1990s, President George H.W. Bush blamed Fed Chairman Alan Greenspan for his election loss to Bill Clinton. Bush didn’t believe Greenspan was lowering interest rates fast enough to pull the nation out of a recession – which gave Clinton, with his famous “it’s the economy, stupid” campaign, an opening to trounce the elder Bush.
Mark Gertler, a professor of economics at New York University, says the lesson of history is that politicians should not interfere with the central bank. “If the Fed doesn’t act independently, the economy is endangered,” said Gertler. “It would be dangerous if the administration appeared to be interfering with the Fed.”
Financial Services Committee Chairman Barney Frank (D-Mass.) doubts they’ll be any daylight between Obama and Bernanke – who Obama just reappointed over the summer at a time when Wall Street needed a signal that there would be continuity at the Fed.
He argues that Bernanke and Obama will have the same agenda in 2010: fixing the economy.
“I think they are very much in sync,” said Frank. Asked about potential divergence between the Fed and the White House, he said, “That reflects a journalist’s hope that there will be friction. Obama and Bernanke have both argued that at some point they’re going to unwind this.”
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