BEN BERNANKE'S NEXT FOUR YEARS

Editorial
At a time when political tempers are running high and world markets remain jittery, Barack Obama has made the right decision to keep Ben Bernanke on for a second term as chairman of the Federal Reserve Board. The Senate must now proceed with hearings to remove the remaining uncertainty.
Mr Bernanke's scholarship and experience prepare him perfectly for the choices facing the Fed. He did not grasp the scale of the subprime problem early enough, but his handling of the crisis since it broke has been decisive and his judgment reassuringly pragmatic. He is the right person for the job.
If confirmed, he faces two major challenges. The first is obvious: get the US out of the recession and into sustained recovery. The Fed must continue to soften the impact of banks' deleveraging while keeping future inflation expectations in check. Mr Bernanke makes clear that money will remain loose for now. He also takes care to explain that an exit strategy exists but now is not the time to launch it.
The second challenge is, if possible, greater. Mr Bernanke will shape central banking for years to come. Two priorities must guide him: obtaining powers for the Fed to be an effective guardian of financial stability; and protecting its independence. The former must not undermine the latter.
The Fed must be put in charge of regulating systemic risk. It alone has the resources and expertise. Systemic stability – which rests on how capital is leveraged throughout the financial system – is intimately linked with monetary policy and liquidity provision.
But capital affects solvency and not just liquidity. This is politically touchier than interest rates: By propping up companies deemed too large to fail with guarantees and shotgun weddings, the Fed put public money on the line to bail out those who put the system at risk. This has prompted calls for greater control over its actions.
Notwithstanding the strong case for democratic oversight over public funds, intrusive scrutiny would inevitably spill over to monetary matters. That must be averted: independent monetary policy has been a success in achieving price stability, its stated goal. Indeed there is every reason to think that policy independence would benefit systemic risk regulation as well.
Mr Bernanke must eschew easily politicised decisions. He must push for a regime demanding “living wills” from large banks and provides automatic fresh capital from debt-for-equity swaps in insolvency, limiting his role in deciding who may live on what terms.
The Fed could then focus on setting market-wide capital ratios to damp asset bubbles. Such decisions would not escape political controversy, but could be sheltered, and defended, as technical instruments for specified stability goals, like interest rate decisions today. This would require new models for what central banks should target. But this is work that the Fed and Mr Bernanke are well placed to do.
Keeping politics out of the Fed requires keeping the Fed out of politics. Mr Bernanke must use his hearings to show he can do this.
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