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In Troubled Economic Times, Bernanke Must Go

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Dean Baker
NPR, January 26, 2010

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Ben Bernanke is one of the country's leading scholars on the Great Depression. He also moved effectively, after the collapse of Lehman, to prevent the downturn from being even worse than it is. However, neither of these facts comes close to justifying his reappointment as the Federal Reserve chair.

The most basic reason for not reappointing Bernanke is that he, along with Alan Greenspan, is largely responsible for the worst economic crisis since the Great Depression because he failed to stem the growth of the housing bubble. (Bernanke became one of the seven members of the Fed's Board of Governors in the summer of 2002.)

It should have been easy to spot the housing bubble long before it grew large enough to pose such an enormous danger to the U.S. economy. Nationwide house prices just kept even with the overall rate of inflation for the 100 years from 1896 to 1996. In the years from the beginning of the bubble in 1996 to 2002, the rise in house prices already exceeded the overall rate of inflation by more than 30 percentage points. Since there was no remotely plausible explanation for this run-up in the fundamentals of the housing market, it should have been apparent to Bernanke and others at the Fed that the housing market was experiencing a bubble.

They should have done everything in their power to burst the bubble, first and foremost providing data documenting the bubble and warning of the consequences of its collapse. They should have also cracked down on the abusive mortgages that became widespread during this period and helped fuel the bubble's growth.

Instead, Bernanke and Greenspan insisted that there was no bubble and that everything was fine in the housing market. As a result, the bubble continued to grow, with the run-up in house prices eventually outpacing inflation by more than 70 percentage points at the peak of the bubble in 2006. The $8 trillion in housing wealth created by this bubble was the driving force in the last recovery.

It was completely predictable both that the bubble would burst and that it would bring down the economy when it did. The failure of Bernanke to take action to stem the growth of this bubble led to a situation in which we now have double-digit unemployment and 20 million homeowners underwater. It is difficult to imagine how a Fed chair could make a more disastrous mistake.

The key point here is that stopping the bubble would have meant confronting the financial industry. This will always be difficult for a regulator, because the industry is so politically powerful. That makes it all the more important to fire Bernanke. If a Fed chair can so completely fail in their job by not confronting the industry and still get reappointed for another term, then there is no way that future Fed chairs will ever confront the financial industry. Confronting the industry will always carry big risks. If there are no consequences from not confronting the industry, even when it is absolutely essential, then economic theory predicts that future Fed chairs will never confront the financial industry. To ensure that we give Fed chairs proper incentive, Bernanke must be fired.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The End of Loser Liberalism: Making Markets Progressive. He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.