Bernanke to Face Questions About Inflation, Deficit

WSJ.com - By GREG IP : "Ben Bernanke, though almost certain to win Senate confirmation as the next Federal Reserve chairman, is likely to face some tough questions at tomorrow's confirmation hearing on his advocacy of an inflation target, his views on the budget deficit and tax cuts and his independence from President Bush.

Mr. Bernanke, who served three years on the Federal Reserve Board, is chairman of Mr. Bush's Council of Economic Advisers. Even Democrats say confirmation seems assured. "We can disagree on policy but ... at this juncture, [the nomination] appears noncontroversial," said Sen. Jack Reed, a Rhode Island Democrat and member of the Senate Banking Committee, which will hold the hearing.

Still, there will be questions. Here are some crucial issues and what to expect:

Mr. Bernanke long has advocated setting an explicit, numerical target for inflation, perhaps 1% to 2% excluding food and energy, to strengthen the Fed's anti-inflation credibility, improve its accountability and guide expectations. Skeptics, including current Chairman Alan Greenspan, think such a target might limit the Fed's flexibility to respond to threats to growth and employment.

Many senators agree. "When he was nominated, Mr. Bernanke said he would pursue the policies of Greenspan," said Sen. Paul Sarbanes of Maryland, the panel's senior Democrat. "We have to square that statement with past statements about inflation targeting. The European Central Bank does inflation targeting, and ... there's a generally held view it's been to the detriment of economic growth and employment."

At the 2002 hearing on his nomination to serve as a Fed governor, Mr. Bernanke told Mr. Sarbanes, "I would not return inflation to its target at the expense of creating a deep recession." The Fed has raised short-term rates to 4% from 1% since June 2004, and Mr.Greenspan is expected to raise them to 4.5% before retiring at the end of January. Mr. Bernanke may be pressed on whether he expects to raise rates further, though he is unlikely to give a definitive answer. Some analysts expect him to lift rates in part to prove he is as determined an inflation fighter as Mr.Greenspan.

Mr. Reed said he is worried about the Fed raising rates "to demonstrate toughness" when the economic data don't support it. While economists believe low inflation doesn't require higher unemployment in the long run, Mr. Reed said, "We live in a much shorter run."

Other senators, including several Republicans, are likely to urge that the Fed remain focused on inflation, with or without a target. "If we have price stability ... economic history has shown that we will have a flourishing economy," said the committee's chairman, Richard Shelby of Alabama. Utah Republican Sen. Robert Bennett said maintaining continuity with Greenspan "means focusing on price stability, first and foremost."

Several senators say the Fed is free to set an inflation target without consulting them. Some Fed officials and academics have argued that adoption of a target might require consultation with Congress and the White House and perhaps even a revision of the Federal Reserve Act. "I would not want Congress to do the Fed's job," said Mr. Shelby. "It shouldn't be put in legislation, it should be left up to the [Fed's] board of governors."

Mr. Bernanke previously has indicated he would be less vocal on economic matters outside of monetary policy than Mr. Greenspan has been, but that won't stop senators from pressing him. "It's important for a Fed chairman to realize this is not an isolated role he plays," Mr. Shelby said.

Sen. Chris Dodd, a Connecticut Democrat, said he may not agree with the Fed chairman's fiscal-policy advice, but he wants to hear it anyway. "If there's a genuine feeling the chairman of the Fed is independently expressing cautiously his views on fiscal policy because it's important for monetary policy, that's welcomed," Mr. Dodd said.

As chairman of the Council of Economic Advisers, Mr. Bernanke has advocated extension of Mr. Bush's tax cuts, including the 15% rate on capital gains and dividends that will expire in 2008 without congressional action. The Senate Finance Committee last week ran into trouble getting the votes for a bill that would extend those tax cuts; it plans to try again today.

New York Democrat Charles Schumer said Mr. Bernanke told him in a meeting last week that his advocacy of the Bush tax cuts reflected his current job as a presidential adviser. As Fed chairman, Mr. Bernanke would "jawbone when the deficit was out of control," and like Mr. Greenspan, thinks there should be some form of "Paygo" budget rule, which in the past has required tax cuts to be offset with spending reductions, according to Mr. Schumer.

Political Independence

Mr. Bernanke almost certainly will be questioned on how independent he will be from Mr. Bush. He will have to walk a fine line -- reassuring senators without repudiating any White House policies. Mr. Bennett said it is "not appropriate" to expect Mr. Bernanke to defend positions he took as a White House official. But, he added, "if the Democrats want to ... demagogue the issue, they will. This is a confirmation, and everything is fair game."

Mr. Dodd said that while he understands Mr. Bernanke's recent statements reflect his current job, "I'm expecting [him] to evaluate those decisions based on his role as chairman of the Federal Reserve Board rather than someone hired by the president to advance his political and economic agenda."

Banks and Consumer Regulations

The Fed has been working on the adoption in the U.S. of new international bank-capital standards known as Basel II, under which the largest banks would be able to determine for themselves how much capital to keep.

Mr. Bernanke backed the standards as a Fed governor. Legislators in both parties fret Basel II may be unfair to small banks and leave big banks with too little capital. "A lot of us are concerned about safety and soundness," said Mr. Shelby.

Mr. Bennett may challenge Mr. Bernanke on the Fed's position on "industrial loan companies," which are lenders insured by the Federal Deposit Insurance Corp. that can be owned by industrial firms.

The Fed has opposed granting ILCs any additional bank-like powers unless their owners agree to be regulated by the Fed, as bank holding companies must. At present, the FDIC regulates ILCs. When Mr. Bennett raised his objections to the Fed's position on ILCs, many of which are based in Utah, he says Mr. Bernanke was "diplomatically nodding while not committing himself.""