Bernanke author defends the Fed chief

You say it's a mistake to look at Bernanke through Greenspan glasses, since one became a legend during almost two decades as Fed chief and the other has held the position for only two-and-a-half years. But I have to throw in one comparison question: Whom do you think is better suited for getting us out of this economic downturn — the fearless leader or the thoughtful analyst?

If you look at Bernanke's background, he's actually in some ways better trained than Greenspan. Bernanke is a big student of the Great Depression. He understands very well the nature of financial and economic crises, the aggressive policies needed in a crises. He's also an expert on the interaction of credit markets and the economy, which is again one of the big challenges facing us today. He doesn't have the almost 20-year experience as Greenspan, but he has the right training. Bernanke is probably a little more creative on how he thought about using the Federal Reserve's tools to affect the crisis. He is disadvantaged that he doesn't have the same confidence from the markets that Greenspan has as a long veteran as Fed chief. Greenspan would have done a reasonable job and Bernanke has done a reasonable job.

Bernanke certainly has a deeper understanding of the academic research and tends to rely more on the views of other economists and the Federal Reserve, and in that way, in the long run, you're better off having a broader reliance on different people's work and views. In the long run, you make fewer mistakes, you take more of a committee-type decision-making approach. Bernanke is new to the job. Over time, you can see, Bernanke's learning very quickly a very challenging job.

Bernanke has been criticized as a flip-flopper, and the markets don’t have the same confidence in him that they did/do in Greenspan. Bernanke has said the Fed is concerned about inflation, and then the central bank goes and cuts interest rates. In your book, you say the flip-flopping is in part due to the challenging economy. Do you think it’s possible to predict Bernanke’s actions?

The perceived flip-flopping in the Fed is due to the rapidly evolving economy. They think they've stemmed the problems and then start easing. Some of that perception of the flip-flopping is that he's a lower profile person than Greenspan was. He would be better off talking to the markets more and explaining the Fed's stance better. People kept on expecting him to be like Greenspan and dropping secret hints. Bernanke is a much more straight speaker than Greenspan. You don't need a decoder ring to decode his speeches. The market has overreacted to his speeches. As far as predicting his actions going forward, the markets are starting to get used to his style and as the economic environment gets more stable, he'll get more predictable.

Since Bernanke took the helm at the Federal Reserve, the economy has soured. In your book, you say his legendary predecessor, Greenspan, may be more to blame than him. Why is that? And do you think Bernanke has worsened the economy at all?

It takes time for monetary policy to change the economy. A new chairman of the Federal Reserve inherits trends in the economy from their predecessor. What Bernanke inherited were bubbles in the housing and credit markets. Home prices went up too far and too fast. Credit markets had gone too loose, lending rates were too low and weren't assessing risks properly. The economy had grown too fast. You had seen inflation as far as consumer prices. These conditions already existed when Bernanke came to the job and got worse in the two years he has been chairman.

The worsening had more to do with the fact that Greenspan, in hindsight, didn't put the brakes on enough. He didn't try hard enough to resist the bubbles and resist inflation pressures. In that sense, the problems we've seen in the economy were more Greenspan's mistakes. The reality is, the economy has ups and downs and the Fed can't always control it. I am not sure I'd put a lot of blame on Greenspan, either. We tend to have recession every five or 10 years. It's just the nature of a free-market economy.

As far as policy choices Bernanke has made, they made sense at the time, but perhaps he was too slow to recognize the scale of the shock to the economy. If he made a mistake, he had plenty of company. My own forecast underestimated the shock to the economy. Given the information he had at the time, he hasn't made any serious mistakes as a central banker.

Bernanke and his legendary predecessor, Greenspan, both believe economists can’t predict asset bubbles such as those in the housing and credit markets. You challenge this mindset in your book. Do you think our economic downturn could have been prevented if either Greenspan or Bernanke had a pre-emptive plan against asset bubbles?

Bernanke and Greenspan and a number of senior officials at the Fed have argued that it's too hard to identify an asset bubble and it's too hard to stop it for it to be worth trying. The credit and housing markets are unfortunate developments. We had some sense but couldn't confidently predict it. But if you spend your time always trying to manage your markets, you'll lose sight of your other goals of managing consumer prices and growth. I have sympathy for that view.

The Fed position is a little too extreme. What the Greenspan Fed should have done is pushed harder on the brakes when it seemed like there were compelling signs of the housing bubble. It's hard to tell the difference in rapid and irrationally rapid price increases, but by 2004 and 2005, the housing market was clearly becoming a bubble. We could see it in the increase of people buying homes — and in purposely buying for investment reasons — and exotic mortgages and the extremely rapid price increases. What the Fed should have done was to lean against it, raise rates more, establish tighter regulations in the housing market, put together tools to slow the market down, not stop the bubble, but reduce the inflation. Markets are going to go up and down, once in a while will go in a bubble and will pop. The Fed can't prevent it completely but can prevent the size.

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