Fed change hints at inflation target

Central bankers from Britain to New Zealand may identify with Ben Bernanke's Federal Reserve more than they did Alan Greenspan's.

Three years since he used his position as a Fed governor to break with Greenspan and advocate a specific inflation goal when setting interest rates, Bernanke, co-author of the book Inflation Targeting: Lessons from the International Experience, has been nominated by President George W. Bush to succeed Greenspan as Fed chairman on February 1.

The nomination, which is subject to confirmation by the United States Senate, may nudge the Fed in the direction of more than 20 foreign central banks that pursue numerical inflation levels or ranges, say global economists and former central bankers. The debate's outcome will shape how the Fed counters inflation pressure from sources such as surging energy costs after the Greenspan era comes to an end.

"Bernanke's appointment brings us one step closer to the Fed targeting inflation like others do," said Jim O'Neill, chief economist at Goldman Sachs in London.

The discussion may heat up just as the Fed struggles to keep a rein on prices. Although it lifted its benchmark lending rate 11 times over the past 15 months, to 3.75 per cent, from the lowest level in 46 years, inflation has moved higher by every measure.

Greenspan argues that there is not enough evidence to prove that inflation targeting can work, and advocates a discretionary approach to satisfying the Fed's dual mandate of keeping prices stable and fostering employment.

Bernanke, 51, and investors such as Pacific Investment Management's Bill Gross, say a numerical target can bolster central banks' inflation-fighting credibility with financial markets, businesses and consumers.

"That has been successful in other economies" such as Britain and the dozen-nation euro region, said Gross, chief investment officer at Pimco and manager of the world's largest bond fund.

"It has promoted relatively low and lower long-term rates in those economies than in the US."

Greenspan prefers to manage risks, constantly adjusting policy to the shocks and innovations transforming the US$11.7 trillion American economy. That has led to criticism that the Fed has been driven by one man rather than a process.

"I would favour any change in Fed operating procedure that would make it more transparent," said Willem Buiter, a former Bank of England policy-maker and now a professor at the London School of Economics. "It is one of the most opaque central banks and has vague and confusing official objectives."

The Federal Open Market Committee debated inflation targeting in February and decided to defer the discussion.

New Zealand's central bank was the first to adopt an inflation aim in 1990, said the International Monetary Fund. The Bank of Canada followed in 1991 and the Bank of England in 1992.

At least 21 central banks, including those in Israel, the Czech Republic, Colombia and South Africa, now do the same.

The European Central Bank, which sets rates for the world's second-largest economic bloc, also seeks to steer inflation within a particular range. Chief economist Otmar Issing says the bank does not target inflation, but it seeks to keep price appreciation just below 2 per cent.

Issing has said he is comfortable with rates between 1.7 and 1.9 per cent.

Juergen von Hagen, a professor of economics at the University of Bonn who has known Bernanke since the late 1980s, said it was unlikely Congress would seek to change the Fed's remit and introduce an inflation target, but Robert Barrie, chief European economist at Credit Suisse First Boston in London, said Bernanke's nomination indicated Bush might want to do so.

Ben Bernanke

* Ben Bernanke is the chairman of the Council of Economic Advisers.

* He graduated summa cum laude from Harvard University in 1975 with a bachelor's degree in economics.

* He received his doctorate in economics from the Massachusetts Institute of Technology in 1979.

* A "star" teacher at Princeton, and chairman of the economics department, he was a governor of the Federal Reserve from 2002 until June this year.

* Bernanke grew up in Dillon, South Carolina, and is married with two children. In high school, he reportedly taught himself calculus because his school did not offer the subject.

- BLOOMBERG