WASHINGTON — President Barack Obama's reappointment of Federal Reserve Chairman Ben Bernanke Tuesday sent a reassuring message of continuity to financial markets and signaled to foreign lenders that the Obama administration won't tolerate a return to high inflation.
Interrupting his vacation on Martha's Vineyard, Obama appeared before the cameras with Bernanke to announce that he was nominating the Fed chairman for reappointment, pending congressional approval, for another four years when his first term as head of the nation's central bank expires in January 2010.
"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and out-of-the-box thinking that has helped put the brakes on our economic freefall," Obama said of Bernanke, whose reappointment was announced half an hour before the release of new data projecting a larger-than-expected federal deficit over the next decade.
The reappointment of a self-described inflation hawk, however, appeared to be intended to reassure bond markets, which take a longer view of economic activity, and stock markets, which loathe uncertainty.
"This decision sends a strong signal to Wall Street and the international financial community that we're not changing horses in mid-stream during our economic recovery," Martin Regalia, chief economist for the U.S. Chamber of Commerce, said in a statement.
"Over the next year and a half, as the economy stabilizes, we believe Bernanke will be vigilant in responding to our federal deficit, keeping inflation in check and unwinding the Fed's unprecedented expansion of its balance sheet."
The nomination also signals to major creditor nations such as China and Japan that the U.S. is serious about tightening up monetary policy if inflation — rising prices across the economy — rears its head.
"I think the surprise will come later for the White House, when they find that Ben Bernanke is not as accommodative as their re-election prospects might require," said Vincent Reinhart, a former top economist at the Fed and former Bernanke colleague.
Reinhart's implication is that if inflation makes an unwelcome return, Bernanke would quickly raise interest rates and slow a recovering economy.
When asked on numerous occasions in recent months, Obama had refused to commit himself to reappointing Bernanke, considered the world's leading academic expert on the Great Depression. The president reportedly weighed more liberal candidates such as Larry Summers, his chief economic adviser, or Janet Yellen, the president of the Federal Reserve Bank of San Francisco.
Inflation, which erodes the spending power of American consumers and businesses alike, has been in remission since former Fed chairman Paul Volcker led the U.S. economy in a deep recession in 1981-1982 to tame inflation, which peaked at 13.5 percent, and helped spur nearly three decades of sustained economic growth.
Now, however, there are fears that inflation will return amid the current financial crisis. The federal government, stepping in to play a lead economic role while credit markets and lending are impaired, will post a record deficit of $1.58 trillion this year, equal to more than 11 percent of all U.S. economic activity. Over 10 years, the cumulative deficit could be greater than $9 trillion.
Bernanke's critics think that rising government spending and lending will cripple his ability to contain resurgent inflation.
"The Fed has the ability to put money out, it's got the ability to take money back in, and if they don't do that, we will have hyperinflation worse than we had in 1980 and '81," warned Sen. Charles Grassley, R-Iowa, a former Finance Committee chairman.
Government spending and the Fed's planned purchase of $300 billion in long-term Treasury bonds could amount to a back-door route to inflation. Of the trillions the U.S. government owes its creditors, more than half is owed to foreigner buyers. These buyers, worried that the value of their dollar-denominated assets could deteriorate if the dollar weakens or inflation returns, could demand higher interest rates, triggering greater deficits and an even weaker dollar.
Inflationary forces also could be hard to control after the interest rates that banks charge one another have remained near zero for a protracted period of time.
Although widely praised for thawing credit markets and lowering the cost of borrowing for U.S. corporations, Bernanke faces a small but vocal group of detractors who blame him and his predecessor, Alan Greenspan, for keeping interest rates so low in the first half of the decade that it fueled an unsustainable housing bubble.
Bernanke has acknowledged that he was slow to grasp the magnitude of the economic crisis, and he was part of a team that sent mixed messages to the financial sector. The Fed and the Bush administration forced the March 2008 fire sale of investment bank Bear Stearns, then months later in September, let investment bank Lehman Brothers fail. That triggered a panic that resulted, days later, in the Fed rescuing insurance giant American International Group.
On Tuesday, however, Democrats largely embraced the reappointment of a Republican Fed chairman.
"On the whole, Chairman Bernanke's response to the unprecedented economic crisis has been wise and appropriate. He has acted to provide needed liquidity to the economy and has demonstrated that he is fully ready to reverse course when economic conditions dictate," said Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, in a statement.
Republicans largely turned on one of their own.
"The Banking Committee should carefully examine the impact of the Fed's failures as a bank regulator, how such failures contributed to the financial crisis, and whether Chairman Bernanke's performance as the chief regulator merits his reconfirmation," said Alabama Sen. Richard Shelby, the top Republican on the banking committee.
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