YOU'D THINK ALAN GREENSPAN

shows up to work in a clown costume with all the talk about the next Federal Reserve chairman having big shoes to fill. But as Kenneth Kuttner, an economist at Oberlin College, says and most Fed watchers seem to agree Ben Bernanke, President Bush's choice for Greenspan's successor, is just the person to fill that footwear.

"I can't think of anyone with better qualifications than Bernanke," says Kuttner, who has seen the nominee's work firsthand. The two co-wrote a paper this year, published in the Journal of Finance, titled "What Explains the Stock Market's Reaction to Federal Reserve Policy?"

The main question facing Bernanke, who is chairman of the president's Council of Economic Advisers, a onetime Fed governor and former chairman of Princeton's economics department, is whether he will seek to stay the course charted by Greenspan or strike out in a new direction. Thanks in part to Greenspan's able management of the money supply, the U.S. has experienced some of the longest economic booms of its history, punctuated by only the mildest of recessions. And this despite a series of crises, including stock-market crashes in 1987 and 2000-02, the Asian financial meltdown of 1997-98, and the terrorist attacks of Sept. 11, 2001. Most observers say that Greenspan, while certainly not perfect, has done a superb job over his 18 years as chairman.

More recently, Greenspan's long campaign of interest rate hikes has burnished his reputation as an inflation fighter. One point of interest for many, says Kuttner, is Bernanke's open espousal of inflation targeting, in which a central bank sets a specific rate of inflation and a timeframe for achieving it, and sets interest rates accordingly.

SmartMoney.com spoke with Kuttner, who worked in the research departments of the Federal Reserve Banks of New York and Chicago before moving to Oberlin, about how he thinks Bernanke will do in his new job if confirmed.

SmartMoney.com: What was your initial reaction to Bush's choice for Alan Greenspan's successor?

Kenneth Kuttner: You can't think of anyone with better qualifications than Bernanke. There was some concern that Bush would pull a Harriet Miers-type move [and nominate a personal loyalist]. But there's relief that didn't happen.

SM: One of the main differences that has emerged between Greenspan and Bernanke is their approach to containing inflation. How committed do you think Bernanke would be to inflation targeting?

KK: He's written extensively on this. He has a long track record on it and he's made his views on this very clear, unlike any other chairman. When you think about Greenspan, nobody had the slightest idea what his thoughts were on monetary policy [before he was confirmed as chairman]. Bernanke is on record in books, in papers he's written, that very clearly communicate his thoughts. He co-authored a paper on inflationary targeting. At the St. Louis Fed, Bernanke gave a speech on the topic, advocating not quite fully an inflationary-targeting practice, but you might say a soft inflation-targeting proposal... He outlines this clearly, and argues for it quite convincingly.

A lot of central banks have found that it's helpful to articulate what inflation rate it's aiming for. For example, the Bank of England aims for 2%. Bernanke has argued quite lucidly that such a target would be useful for the Fed in terms of explaining what monetary policy is trying to do. Greenspan, in his public comments, expressed a certain amount of reluctance and caution when it comes to inflationary targets. I sense he's in favor of a more discretionary approach, something that wouldn't constrain the Fed's [decisions]... With Bernanke, something like that [inflationary targeting] is likely.

SM: Markets around the world move and react based the slightest nuances of Greenspan's language. Even though Bernanke said on Monday that his first priority is to maintain Greenspan's policies for a while after the transition, is it likely he'll be less ambiguous than Greenspan in his statements?

KK: The statements released following FOMC meetings are very brief. They're very stylized. And yes, markets sometimes react quite strongly to one or two words. I can't say how Bernanke feels about this. But to many Fed watchers like me, it's undesirable how much markets react to certain words. I think it would be helpful if more information is provided. Then there's less sense that the market would read into the statement, deconstructing the word choice...

This is one of the hallmarks of central banks that have inflation targets; they give detailed discussions of what they're doing. Having a full presentation [of the reasons behind the decisions] is consistent with central banks that have inflation targets.

SM: So no more "measured pace" of interest rate increases?

KK: The Fed over the years showed a tendency, generally speaking, to move interest rates incrementally. There have been a few occasions when the Fed was moving more than 25 basis points [a quarter of a percentage point]. The "measured pace" terminology reflects a tendency toward gradualism. Nothing I saw would have Bernanke change that in any way. I think the measured pace terminology entered into the statement to give a sense the intention was to reassure markets the Fed wasn't going to drastically change interest rates, or raise them quickly over a short period of time. They were showing they were sensitive to downside risks. I think the Fed may have gotten itself in a bit of a box. The removal of that phrase might be read as a signal of an acceleration of interest rate hikes. They don't want to frighten people. The terseness of the statement has gotten it in a bit of a bind.

SM: Bernanke has been chairman of the Council of Economic Advisers since June. Do you share some of the concern that this might compromise his political independence in the role of Fed chairman?

KK: Greenspan served on the Council as well. The Council has evolved over time. Now maybe it's not what it used to be... I'm not sure how the CEA is going to change his outlook as chairman. The Fed chairman's job is all about monetary policy. The Council is broader. Your job is not to second-guess monetary policy, but to advise on what the executive branch has control over, like tax policy, things relating to trade, microeconomics. Now that he'll be back at the Fed, he's switching back to a whole separate set of issues. Greenspan in recent years has felt free to offer views on things like fiscal policy which are not in the purview of the Federal Reserve system. The interesting thing will be to see if Bernanke follows in that regard on the advisability of tax cuts, budget balances or if he stays close to the Fed's issues of monetary policy, central banking and the like. There's a certain political dimension when the Fed chairman makes statements about policy...

SM: Will Bernanke need to be more aware of foreign central banks in his decisions than previous chairmen?

KK: There are all kinds of international dimensions to monetary policy, between the U.S. and other major countries and emerging-market economies... Whether it will increase or decrease, I don't know. Some of the international things are on Bernanke's radar screen. One of his most influential speeches over the past year or two was on global imbalances. He came up with the global savings glut hypothesis. It shows he's thinking about these things and the role of monetary policy in relation to these things... The conventional wisdom is that when you have a current account deficit, it can be traced to budget deficits in the U.S.... Bernanke took a careful look at the data and explained that when you look at what's going on in other countries, and current account deficits [between other countries], the usual suspects are not entirely explaining why we have an account deficit. He advanced and discussed his idea that part of the account deficit is in large part because there's a lot of saving and not a lot of investing in other countries, not only in China, but also Latin America. It's an example of when he took a complicated issue and focused on it in a clear way, and offered a new viewpoint on it that many people find compelling.

SM: Do the markets need time to adapt to a new voice?

KK: As soon as the announcement is made, markets make a snap judgment. (I'm working on a paper with Adam Posen now about this.) In the U.S., in past appointments, there have been snap judgments. Bernanke's was favorable. But the decline in bond prices seemed to be associated with a concern that he won't be as tough on inflation as Greenspan was, which I think is unfounded. When Greenspan was nominated, he was an unknown quantity. There was a similar reaction: You had a blip up in bond yields, the dollar weakened for a day or two. But most reacting disappears after three days. Some of the responses have been more long-lived. In [Paul] Volcker's appointment in 1979, it was a big change in Fed policy. Bond yields went up and the dollar strengthened. It becomes more of an issue of what they do than the perception... With Greenspan there was not any direct inflation concern... But Greenspan followed somebody who acquired a tough and legendary reputation at the Fed. My reading of it is that people were asking, Who is this guy? Is he going to be as tough on inflation as Volcker was? There was a bit of a hiccup.

But it's hard to follow Greenspan. He was tough on inflation. When following someone that good, you always have skepticism if they have the will, the power to follow that performance.