Friday, August 31, 2007

Bernanke not just smarter than Greenspan ...

But STRONGER, too:
[today's WSJ] We think, instead, that Mr. Bernanke has been doing well these last few weeks by resisting this belief in the Fed as Yahweh. The central bank has been doing good work in its role as a financial system plumber, plugging leaks as they spring up, and in reassuring banks that its liquidity window is open. Mr. Bernanke has done especially well to resist being bullied by Wall Street, the homebuilders, automakers and easy-money editorialists into opening the broader credit spigots.

Mr. Bernanke is in part a hostage to the legacy of the Alan Greenspan era, when the Fed seemed to ride to the rescue during every financial crisis. This is the famous "Greenspan put," which is as much legend as reality. The current market and media pleas to Mr. Bernanke are in part an attempt to get the new Fed chief to behave as if it is something of a guarantee. But the Fed doesn't have the same flexibility now, in part because its reckless policy in the early part of this decade helped produce the credit excesses we are now trying to work off.

The Fed's first obligation isn't to reflate the bubble but is to protect the larger economy and especially price stability. One economic reality today is that the Fed's debt subsidy led to a misallocation of resources into real estate and certain debt instruments that is in the process of being worked off. The losses are real, and someone will have to pay them. Housing prices will fall in some markets for some time to come. There is no joy in saying so, but this is what happens when credit is no longer subsidized and markets change their risk assessments.

The Fed may well have to act if the economy does begin to stumble. But if that happens, the Fed isn't the only or even the best policy lever. Fiscal policy is also available, which means the Bush Administration and Congress should be considering another tax cut. A tax cut could revive incentives for risk-taking among those feeling burned by the housing fallout. The federal deficit is heading down to 1% of GDP, and nothing would be worse for tax receipts than a recession.

We realize tax cutting is taboo in today's Washington, but if the Presidential candidates aren't considering a tax cut proposal, they should be. The entreaties of Wall Street notwithstanding, the Federal Reserve is no miracle worker.

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