U.S. Federal Reserve Board chairman Ben Bernanke is hitting back at critics of his unconventional stimulus plan, reshaping debates that will determine the future of U.S. economic policy and the international monetary system.
On the controversy surrounding the Fed's plan to create $600-billion (U.S.) to buy financial assets, Mr. Bernanke has resisted a direct fight while absorbing blows from a range of detractors at home and abroad, including Chinese and German government representatives, Tea Party heroine Sarah Palin and newly empowered Republican legislators.
The breadth of the attacks is extraordinary, calling into question both the Fed's ability to operate free of political influence and the United States' stewardship of the world's reserve currency.
The decision to fight back suggests Mr. Bernanke is worried the barrage could undermine confidence in the central bank, which would impede efforts to convince the public that the asset-purchase plan will work. By force of argument, the Fed chief could silence some critics, analysts said. However, the critics of U.S. monetary policy have such momentum that the Fed will be challenged to emerged unscathed.
John Boehner, majority leader in the U.S. House of Representatives, and three other Republican congressional leaders wrote to Mr. Bernanke this week to express "deep concerns" about the Fed's plan to resume purchasing Treasury securities. Two other Republican lawmakers proposed stripping the Fed of its mandate to achieve "maximum employment," leaving policy makers to focus solely on price stability.
External pressure on the Fed is no less severe overseas, where Germany and a group of emerging market countries that includes China and Brazil have accused the U.S. central bank of deliberately trying to weaken the dollar in order to give American exporters a trade advantage.
Anger over the Fed's policies blocked Barack Obama's attempt to get the Group of 20 developed and emerging nations to agree to limit trade surpluses and deficits at last week's summit in Seoul, where the U.S. President was forced into the unusual position of having to defend the policies of the country's independent central bank. French leader Nicolas Sarkozy said in Seoul that the Fed controversy gives momentum to his plan to use France's presidency of the G20 in 2011 to review the international monetary system.
"The Fed's credibility is being challenged," said Karen Dynan, co-director of the economic studies program at the Washington-based Brookings Institution and a former official at the U.S. central bank. "I don't remember any time in recent history that a Fed action has been so controversial."
On Friday, Mr. Bernanke turned the tables on his challengers, using a speech of about 4,200 words in Frankfurt in an attempt to refute characterizations of the Fed's asset-purchase plan as an act of desperation, a blind gamble that will lead to inflation, and a disguised attempt to debase the value of the dollar.
Avoiding the inflammatory language of some of his critics, Mr. Bernanke said there is good reason to believe the Fed's strategy, called quantitative easing by most economists, will successfully lower longer-term interest rates, and that policy makers are well equipped to curb inflation once robust economic growth is in place.
The former Princeton University economics professor even took exception to calling the Fed's strategy quantitative easing, which typically refers to policies that seek to change the quantity of bank reserves. "Securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors' portfolios, on a wider range of assets," Mr. Bernanke said.
The Fed chief also went on the offensive.
China and the other emerging-market countries that have accused the Fed of running a weak-dollar policy run the risk of condemning everyone to "slow growth" by refusing to allow their currencies to appreciate, blocking efforts to balance trade and investment flows, Mr. Bernanke said.
By relying on export-driven growth strategies, emerging-market economies are tying themselves to advanced countries such as the United States. Advanced economies will remain weak until they, too, can generate some wealth from exports, making exchange-rate intervention a self-defeating policy, the Fed chief argued. He also challenged the argument that his policies sparked a rush of capital out of the United States, saying the upward pressure on emerging-market currencies has as much to do with traders anticipating that these countries will eventually have to allow their exchange rates to appreciate to combat inflation.
To his domestic challengers, Mr. Bernanke was about as stern as an apolitical head of an independent institution can be. The U.S. unemployment rate has stagnated near 10 per cent for about 18 months, and only about 900,000 of the 8.4 million jobs lost during the recession have been recovered. Without a jolt to the economy, there is a real risk of "seeing millions of workers unemployed or underemployed for years," Mr. Bernanke said.
"As a society, we should find that outcome unacceptable," he said, suggesting that if politicians don't like what the Fed is doing, they should end their political deadlock and lend a hand.
"The Federal Reserve is non-partisan and does not make recommendations regarding specific tax and spending programs," he said. "However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve."
Mr. Bernanke's speech caused a stir in global financial markets.
Jens Nordvig of Nomura Securities said Mr. Bernanke may have successfully recast the policies of China and other Asian nations as the problem in foreign-exchange markets, while analysts at Barclays Capital said the speech could help mute the criticism the Fed has been facing.
Others said the Fed chairman may simply have further stirred the hornet's nest. "This is really aggressive for the chairman," said Andy Busch, global currency and public policy strategist at BMO Nesbitt Burns in Chicago. "This is setting up some large fights in Congress and globally."
If Mr. Bernanke's goal was to put a stop to efforts by outsiders to take a hard look at Fed policy, his intervention probably came too late. Just ahead of the Seoul summit, Mr. Sarkozy convinced Chinese leader Hu Jintao to host a "seminar" on the international monetary system under the G20 banner, ensuring the Fed will remain under the global microscope for months to come.
At home, the success of the Tea Party movement in this month's mid-term elections will empower politicians such as Texas congressman Ron Paul who question whether a central bank is necessary. Even less extreme voices are advocating changes. John Taylor, a Stanford University economics professor and a former official in George W. Bush's Treasury Department, proposed this week that the Federal Reserve Act be rewritten to limit the Fed's discretion by requiring policy makers to regularly tell Congress the methodology they will follow to meet their inflation and growth targets.
"The Fed has injected itself into politics," said BMO's Mr. Busch, who predicted there will be a legislative attempt to curb the central bank's mandate. "They have taken the gloves off and put themselves in this position."