Bernanke’s Test: Ben Bernanke, Alan Greenspan, And The Drama Of The Central Banker;
By Johan Van Overtveldt; Agate Publishing;
Pages: 287; Price: $26
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There is one school of thought that blames much of the current financial meltdown on Alan Greenspan’s monetary policies. Many columns have been written about the celebrated central banker’s tendency to keep policy rates too low for too long a period during 2002-05, which contributed to the housing bubble, the subprime mortgage, and other such problems.
Meanwhile, monetary policy is also being used as the main weapon in most countries to fight the current problems. From the US to Europe to Japan, monetary policy has been the tool of choice to try and stave off the worst global recession over 50 years. Even in India, the first two stimulus packages to give a boost to the economy have been largely based on monetary policy. But just how much influence does monetary policy have in booms and busts? Was it a monetary policy error that led to the job losses of the Great Depression? And will the lessons learnt from monetary policy errors in the past help in preventing the world from slipping into another Great Depression?
All these questions are examined in great detail in Bernanke’s Test. In some ways, the title of the book is misleading. Sure, Ben Bernanke is the main protagonist. But this book is not narrowly focused on the current US Federal Reserve chairman — it is actually a detailed history of the evolution of the US central bank’s monetary policies, from Paul Volcker to Greenspan to Bernanke. It examines their economic philosophies and their personalities. It also examines in some depth the role and influence of Milton Friedman’s seminal study of the Great Depression on the three central bankers, especially Bernanke.
To the world at large, the role of central bankers is a bit of a mystery. Yes, the generally informed public knows that central bankers decide on interest rates, and are supposed to use money supply to combat inflation and other such ills. But how they arrive at ‘what the correct rate is supposed to be’ is quite incomprehensible to even otherwise informed businessmen. Meanwhile, most economists who are not focused on monetary policy have one of two views on the central banker’s role. One school believes that monetary policy is a very subtle and complex tool that requires a great deal of understanding and immense intelligence to apply properly. Another school believes that monetary policy is essentially a technician’s job — applying a specific formula and adjusting policy rates according to inflationary trends.
 Johan Van Overtveldt is director of the Belgium-based think tank VKW Metena. He was formerly the chief economist for the Belgian news magazine Trends. Overtveldt contributes frequently to the Wall Street Journal, Europe, and other publications. He is also the author of The Chicago School: How The University Of Chicago Assembled The Thinkers Who Revolutionized Economics And Business. |
As Overtveldt shows, there is enough truth in both these positions. Bernanke’s predecessor Greenspan was the prime example of how this works. Greenspan firmly believed the role of monetary policy is to manage risk. He held that given the imperfect knowledge of what was actually going to impact the economy in the short- and medium-run, the role of the central banker was all about making trade-offs, and the best choice from a range of options. He argued that a certain amount of judgement in policymaking was essential to manage the task properly.
But a long-term evaluation of the interest rate changes during his 20-year stint as the Fed chairman actually shows that he followed something called Taylor’s Rules, which essentially is a formula as to how much a central bank should change interest rates in response to inflation rates diverging from target inflation rates. In essence, despite his belief the central banker needed to exercise a lot of judgement, Greenspan was largely following a set mathematical formula.
Greenspan dominates much of the first half of the book, but Bernanke makes up the second half. There is a lot of analysis on Bernanke’s more controversial theories — including the statement that the global savings glut was largely responsible for the current account deficit faced by the US. It also examines Bernanke’s obsession with the Great Depression — he wrote a paper on it while still in college — to put in context many of the decisions the current US Fed chairman is taking.
There are a couple of chapters tracking the step-by-step descent into chaos in the financial system, despite the efforts by the central bank to try and manage a soft landing. And it ends with a hard look at the challenges faced by Bernanke as he battles to keep the US economy from sliding into a major depression by using the monetary policy tools at his disposal.
This is a wonderful book to understand the nuances of monetary policy, simply because it is written in a clear and concise language. It could easily have lapsed into a technical dissertation, but it avoids that pitfall quite admirably. And it gives the monetary policy view on what caused the current crisis. A good explanation of how we got into the mess we got into.
Prosenjit Datta is the editor of Businessworld Magazine
This review was published in the Businessworld Issue Dated 9-15 June 2009
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