Bernanke in the crosshairs

REPUBLICANS have trumpeted their victory in the mid-term elections as a revolt against big government, from bail-outs to fiscal stimulus. Having made short work of the Democratic Congress, it was inevitable that they would next turn their sights on the Federal Reserve, a perennial target of the wilder-eyed.

On November 3rd the Fed said it would buy $600 billion-worth of Treasury bonds over the next eight months with newly printed money. This second round of quantitative easing (QE), the Fed hopes, will nudge down long-term interest rates, thus stimulating spending and fending off the threat of deflation.

Republicans and “tea-party” activists erupted in criticism. “Cease and desist,” cried Sarah Palin, a former vice-presidential candidate. “Currency debasement and inflation,” declared a gaggle of conservative economists and commentators in an open letter published as a full-page ad in leading newspapers. Republican leaders in Congress wrote to Ben Bernanke, the Fed chairman, to express “deep concerns”; and two of their colleagues proposed stripping the Fed of its statutory responsibility to promote growth and employment, leaving it to occupy itself only with controlling inflation.

At first blush their complaints are perplexing. Core inflation (excluding food and energy) was just 0.6% in the year to October, the lowest since records began in 1957. Even food prices are up only 1.4% from a year earlier, while petrol prices are well below their peak of 2008. In a Gallup poll, 33% of respondents called unemployment the most important problem facing the country; just 1% picked inflation. Even the dollar’s recent drop is small beer.

Yet the fight is not ultimately over numbers, but ideology. To be sure, the Fed’s reputation has suffered among Americans of all political stripes over its failure to prevent the crisis and its bail-outs of banks. But the tea-party movement holds it in particularly low regard, seeing it as the monetary bedfellow of the hated stimulus and bail-outs. Some 60% of tea-party activists want the Fed abolished or overhauled, according to a Bloomberg poll. One of the movement’s heroes is Ron Paul, a congressman from Texas who wants to scrap the Fed outright and bring back the gold standard. His son Rand, newly elected as a senator from Kentucky, has also been stridently critical. QE can be made to seem sinister: an animated video on YouTube that portrays it as a conspiracy between Goldman Sachs and the Fed to fleece the taxpayer has been viewed over 2m times.

The ideological content of the backlash should not be overestimated. In 1892 William Jennings Bryan, later the Democratic presidential candidate, declared: “The people of Nebraska are for free silver and I am for free silver. I will look up the arguments later.” Liberals accuse the Republican leadership of likewise concocting an excuse to rally their base against Barack Obama. Indeed, the letter to Mr Bernanke criticises QE2 in much the same language used to oppose fiscal stimulus: as a dampener of business confidence and stability.

Mr Bernanke, himself a Republican, took office in 2006 hoping to stay out of political debates. That is proving difficult. Interest rates are near zero, and quantitative easing is at best a feeble tool for boosting growth; Mr Bernanke, like many economists, thinks more fiscal stimulus is what is needed now. Some Republicans saw a speech he made to that effect on November 19th as a partisan act. “The politicisation of the Fed has occurred,” says Tom Price, a Republican congressman from Georgia and sponsor of a bill that would remove full employment as one of the Fed’s goals. “The problem is it’s been on the administration’s side and not on the congressional side. We’ve got a Federal Reserve that is in essence monetising the debt and encouraging more deficit spending.”

These broadsides are less threatening to the Fed’s independence than they appear. Senate Democrats could block, and Mr Obama could veto, any change to the Fed’s mandate. And besides, the Fed’s expanded mandate of 1977, to promote “maximum employment, stable prices, and moderate long-term interest rates” has never made much economic sense, since the only thing the Fed can really affect is inflation. In practice it behaves much like central banks, for whom controlling inflation is the only mandate. A simpler mandate would actually fit with Mr Bernanke’s own desire for a numerical inflation target, probably 2%.

Republicans can make Mr Bernanke’s life difficult with hostile oversight hearings; ominously Mr (Ron) Paul will become chairman of the House subcommittee on monetary policy next year. But most analysts still expect the latest round of QE to be completed as planned.

A bigger question is whether the Fed will engage in any further QE if the economy stays weak. There the greatest obstacle is growing unease within the Fed itself. Tom Hoenig, president of the Federal Reserve Bank of Kansas City, has recently stepped up his criticism, calling QE a “bargain with the devil”. On November 8th Kevin Warsh, a Fed governor who has long been Mr Bernanke’s most loyal ally, questioned the wisdom of QE in a Wall Street Journal article. Several other QE sceptics will get votes on the Fed’s main policy committee next year.

Mr Bernanke may plan to stay the course, but the chorus of criticism is already doing damage. It has nourished investors’ doubts that the Fed will finish, much less add to, the planned $600 billion in bond purchases. That has helped drive up long-term bond yields from 2.53% the day after the Fed’s announcement to 2.8% now, precisely the opposite of what QE was meant to achieve. If those perceptions stick, QE will be seen to have failed and the critics will have won. Unfortunately, the same will not be true of the economy.