Critics are attacking Ben Bernanke from all sides. Most
recently, some have been arguing that the Federal Reserve chairman
did a poor job of explaining how the central bank would cut back
its massive bond-buying campaign, sending markets around the world
into a tizzy. Before that, Bernanke's detractors argued that his
aggressive monetary policies were producing bubbles in both the
stock and housing markets and were setting the stage for damaging
inflation in the future.
Yet a close look at the evidence reveals something quite
different: The Fed's accommodative policy has helped the U.S.
achieve one of the strongest recoveries among the developed
nations. But the strength of the stock and housing markets is now
based on fundamental economic developments, not just Fed
The stock and housing markets are nowhere near bubble territory.
Stocks are trading near their average historical ratio of price to
earnings and are still cheap when compared with bonds and cash. And
housing prices are still well below the bubble highs of 2005.
Driving the housing market are record-low interest rates and
record-high "affordability," an index of mortgage costs relative to
average family income.
It's hard to overemphasize the importance of the housing market
and home prices to the health of the economy. Home equity is still
the average American family's most important asset. And thanks to
the rising stock market, it's far more pleasant to look at
quarterly 401(k) statements than it was four years ago. Indeed, the
recovering stock and housing markets are a major reason the U.S.
economy is still growing while others are faltering.
Fed critics concede these points but argue that all the positive
developments are the result of the low interest rates the Fed has
engineered. But low rates also reflect fundamental changes in the
economy--namely, slower growth and both aging baby-boomers and
pension funds shifting money from stocks to bonds. Although rates
will rise as the economy strengthens (indeed, the yield of the
benchmark ten-year Treasury bond has climbed by almost a full
percentage point since early May), it is likely that these powerful
forces will keep them relatively low for years to come.
Critics also charge that the Fed's policy of flooding the
banking system with reserves, which it uses to buy long-term
government bonds, could cause inflation to surge. To be sure, the
Fed has more than tripled its balance sheet and created nearly $2
trillion of excess reserves since the financial crisis. But when
the time comes to unwind this liquidity, the Fed need not sell all
its bonds. It could absorb most of the excess by raising the amount
of reserves banks must set aside to cover deposits--a powerful
monetary tool that has lain dormant for years. By raising required
reserves, the Fed can begin tightening without unduly pressuring
the bond market.
Prices under control. Despite all of the monetary easing,
inflation has been declining, not increasing. Inflation has
remained low because the liquidity the Fed created is not being
spent. Rather, it's being held as excess reserves by banks, and
businesses and individuals are hanging on to cash. Without the
Fed's actions, Americans would be facing the same kind of deflation
we suffered in the Great Depression, with disastrous economic
Moreover, it is wrong to argue that the Fed has abandoned its
battle against inflation. Under Bernanke, the Fed established for
the first time a long-term target for inflation (2%) and a
short-term inflation trigger (2.5%) for when the central bank would
begin to tighten monetary policy.
I have not agreed with all of Bernanke's actions. But I believe
his strategy for dealing with the financial crisis was correct and
that his current policy, which has garnered so much criticism, is
the right response to a sluggish recovery. The gains we see now are
based on improving fundamentals and rising consumer confidence.
These gains will continue even when the Fed takes its foot off the
monetary gas pedal.
Columnist Jeremy J. Siegel is a professor at the University of
Pennsylvania's Wharton School and the author of Stocks for the Long
Run and The Future for Investors.