Bernanke reappointment makes perfect sense

Most financial commentators approved when President Obama two weeks ago reappointed Ben Bernanke as Federal Reserve Board chairman. However, in most of the commentaries, the approval was based on the belief that it would be unwise for the president to introduce more uncertainty into the financial markets at this critical period in the recovery.

And they were correct that changing horses in the middle of a flooded stream wouldn’t be a good idea.

Even financial advisers agree with the president’s decision. In an InvestmentNews survey conducted online after Mr. Obama announced his decision, 84.7% of the 787 advisers who responded said they support the decision to reappoint Mr. Bernanke.

Certainly, Mr. Ber-nanke missed the bubble signals, but he is unlikely to do so again. There are other im-portant reasons why the reappointment was the right move.

First, Mr. Bernanke is one of the foremost experts on the causes of the Great Depression. It has been one of the key issues of his scholarship during his academic career.

While acknowledging the work of the late Nobel laureate economist Milton Friedman and his co-author Anna Schwartz, whose studies highlighted the role of the Federal Reserve in creating the Great Depression, Mr. Bernanke identified other contributing causes.

In particular, Mr. Bernanke focused on the role of private banks and other financial institutions, and the decline in the availability of credit and the rise in its cost that caused a cutback in lending, deepening the crisis.

In his paper “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression” (The American Economic Review, June 1983), Mr. Bernanke wrote: “Some borrowers (especially households, farmers and small firms) found credit to be expensive and difficult to obtain. The effects of this credit squeeze on aggregate demand helped convert the severe, but not unprecedented, downturn of 1929-30 into a protracted depression.”

Second, Mr. Bernanke has lived through an extraordinary period when he has been able to see what has worked and what hasn’t.

Third, he has also focused on the dangers of deflation and inflation, and is aware that the rapid growth in the money supply in the second half last year, combined with all the federal government’s stimulus spending, is dry tinder just waiting for a spark to set off roaring inflation.

The key decision for the Fed will be when and how to remove the monetary part of the stimulus without triggering a relapse into recession as occurred in 1937.

Mr. Bernanke and his colleagues have begun to reduce the growth rate of the money supply, but they appear to be doing so cautiously. Already, the growth rate of M2, which ran at an annual rate of 12% between October 2008 and January 2009, has slowed to a little over 3%.

If anyone can steer the Fed between the Scylla of a double-digit recession and the Charybdis of surging inflation, it is Mr. Bernanke.

There is no guarantee that the Fed will get it right, but the chances are far better with Mr. Bernanke at the helm than with any of the other likely candidates, who haven’t been tested by fire.