Count on Bernanke to fight inflation

In just under two months, arguably the single most powerful economic force in the United States — and possibly the world — will have a new name: Ben Bernanke.

As the new chairman of the Federal Reserve Board, he — and no longer Alan Greenspan — ultimately will be responsible for determining the course of short-term interest rates and the money supply in an attempt to maintain balance between boom and bust in the U.S. economy.

He comes with excellent credentials. He was educated at Harvard and MIT, is well regarded by those who have worked under him, and most recently was chairman of the president’s Council of Economic Advisers. He has also served under Greenspan as a member of the Board of Governors of the Federal Reserve System.

So far, most analysts have assumed that Bernanke will follow Greenspan’s policies. True, Bernanke learned monetary policy under Greenspan to some degree. But it would be naïve to assume more of the same. Bernanke will react to events in the economy in his own way, with his own assessments and his own goals.

What, then, can we expect of the new boss at the Fed?

First, we cannot expect to have hard evidence too soon. Bernanke takes over Feb. 1, a day after the Fed meets under Greenspan for the last time. His first public move won’t come until March 28, when he will preside over a Fed meeting to decide the next move on interest rates.

That could mean two months of volatility as the markets try to figure out where Bernanke will take the economy. Much depends on Bernanke’s public statements during that time, which might reveal his intentions, and on the economic statistics that emerge.

We know that Bernanke supports a policy of identifying explicit inflation targets, which Greenspan did not favor. Although expectations remain that inflation targets will take time to adopt, his expected greater transparency will provide some comfort to bond investors and could generally lower risk premiums, as it will be clearer what path short-term rates are likely to take.

In past comments, Bernanke has set the desired core inflation rate — as measured by the core personal consumption expenditures index — at between 1 percent and 2 percent. It’s currently above that level, so Bernanke is likely to keep raising rates until inflation falls back into that range.

The fear remains — as it did under Greenspan — that Bernanke might raise short-term rates too far. He might want to prove to the bond market that he is serious about fighting inflation.

The problem is that raising rates too far could plunge the country into recession.

We can therefore conclude that inflation is unlikely to be a problem under Bernanke; his words indicate he is likely to continue Greenspan’s inflation-fighting legacy.

The only fear is that he might crush it too vigorously.