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YOU DECIDE: Should you care about Bernanke's reappointment?

September 04, 2009

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu


Dr. Mike Walden
Media representatives:For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

Every four years we elect a president. But another very important person takes office every four years who, many say, eclipses the president in impact over the economy. This person is the chair of the Federal Reserve System, and we now know who this will be for the upcoming term - Ben Bernanke.

The head of the Federal Reserve is appointed by the president and confirmed by the Senate. Every president has an opportunity to appoint at least one Fed head, although not necessarily at the beginning of the president's term. Fed heads are not subject to term limits (like presidents are). Alan Greenspan served almost five full terms running the Federal Reserve, and Mr. Bernanke has been nominated for his second full term.

So why should you care who's at the top of the Federal Reserve? You should care because the Fed has enormous power over our daily lives. Some have called the Federal Reserve the fourth branch of government. The Fed can move interest rates up and down and therefore make it harder or easier for you and me to borrow money. The Fed can also create money - literally - and thereby expand or contract the amount of credit banks have to lend.

And as we've seen in the last 18 months, the Fed can also be creative and do things outside its traditional box of authority, things like making loans to institutions other than banks and establishing lending programs for commercial and consumer borrowers.

Whether these actions by the Fed have been right or wrong (and there's a great deal of debate over this point), the man primarily responsible for them - Ben Bernanke - will likely be in charge of the Fed for another four years. So what policies do we have to look forward to and how will those policies impact our wallets and prosperity?

Chairman Bernanke's immediate task will be to make sure the economy recovers from the recession and that the recovery has legs. This means for the near future, the Fed will keep its interest rates low and its credit ample.

But at some point Chairman Bernanke and his colleagues will have to take some of the candy away. They'll have to nudge up interest rates and withdraw part of the credit they've created. If not, there's a real danger the lending and spending generated from the low rates and plentiful credit will overwhelm the economic system and result in an inflationary explosion.

This movement to tighter credit will be tricky. If done too soon, it could snuff out the economic recovery. If done too late, the faster inflation may already be guaranteed.

There's another looming challenge for Mr. Bernanke and company, and that's a clash with the federal budget. Recent reports predict the federal government will need to borrow $9 trillion over the next decade. One potential buyer of at least some of this debt is the Federal Reserve. Indeed, it's easy for the Federal Reserve to purchase the debt - one click on a computer mouse virtually does the job! Also, when the Fed buys the debt, the government doesn't have to compete for buyers with corporate, state and local issuers of debt.

But where does the Federal Reserve get the money to purchase the government debt? In most cases it simply creates the money. In fact, when the Federal Reserve buys government debt, it's called "monetizing the debt."

However, there's a downside to monetizing the debt. Creating money at a faster clip than the economy is growing can - and usually does - lead to higher inflation. It's the old adage stated by econ 101 professors for generations - inflation results from "too many dollars chasing too few goods."

So if Bernanke and the Fed want to keep a lid on inflation - which they've already said they do - then they'll resist buying newly issued government debt. If the Fed also eventually increases interest rates, borrowing costs for the government will be even higher. At this point, many fingers may be pointed at the Fed to ease up.

So the good news for Bernanke is that he has been reappointed to another four-year term in one of the most important jobs in the world. But this is also the bad news - for him - because the challenges and controversies faced by the Federal Reserve will not ease up. Eventually, we'll all have to decide if this mild-mannered former economics professor was up to the job.

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ncsu.edu/waldenradio/

Posted by Dave at September 4, 2009 08:25 AM