Sizing Up Bernanke

"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.