Fed Chairman Well-Armed to Combat Liquidity Crisis

About Ben Bernanke

BORN: Dec. 13, 1953, in Augusta, Ga.

FAMILY: Wife Anna; two children

EDUCATION: B.A. in economics, 1975, Harvard University; Ph.D. in economics, 1979, The Massachusetts Institute of Technology

EXPERIENCE: June 2005-present, chairman, President's Council of Economic Advisers; 2002-2005, member, the Board of Governors of the Federal Reserve System; 1996-2002, professor and chairman of the Economics Department at Princeton University; 1985-2002, economics professor, Princeton University

During the recent stock market turmoil, investors around the world have been looking to one man above all others. Ben Bernanke, the chairman of the Federal Reserve, America's central banker, has more power than any other single person to affect how this financial turmoil plays out. It's fair to say that Bernanke has been preparing for this moment for at least 24 years.

Berkeley economist Barry Eichengreen says Bernanke wrote a famous 1983 paper that forever changed how economists understand the Great Depression. His work on the Great Depression could have a huge impact on how he acts right now.

Why did Bernanke focus his most important work on the Great Depression?

"It's just like a physicist who studies the Big Bang," says Adam Posen of the Peterson Institute for International Economics. "Macroeconomists study extreme cases, and the Great Depression is our extreme case."

Posen says the Depression was not like now. It started with a much more severe stock market downturn in 1929. That was bad. But it could have blown over, if the Federal Reserve had acted correctly. Bernanke showed that the Fed made things much worse. It kept interest rates high — even as the economy was collapsing. And that dried up available credit to businesses and people facing hard times.

Imagine you're a farmer or restaurant owner in 1930 in some Midwestern town. The stock market collapsed in New York, but you don't own stocks. You're doing OK. But you do need a loan from a bank to buy a new stove or get some feed for your cattle.

Suddenly, the bank — which is affected by stock prices — doesn't have available credit to give you a loan. Suddenly, you can't buy that new stove. You have to sell some of your cattle.

Without credit, people lose their businesses and their jobs. The economy collapses.

The economy is still quite strong today, but there are troubling signs. Credit has become more scarce in the past couple of weeks — and many are finding it difficult to get loans.

Bernanke was not the first to realize that a credit crunch helped worsen the Great Depression. But he was the one to put the idea through the rigorous mathematical tools of economics. His work has become the standard view, accepted by most economists.

He taught the world that in real credit crises, a Central Bank must make sure there is enough credit in the financial system. But some think Bernanke may now be ignoring his own advice. He has taken a few steps, but he hasn't lowered the main interest rate — the one that really affects the availability of credit. Why not? Why hasn't he done exactly what he thinks the Fed should have done at the onset of the Great Depression?

Posen says it should be heartening that Bernanke isn't all that worried that the economy is in real danger because of the current credit turmoil. At least he isn't yet. After all, he's the guy who taught the world how to think about credit crises.

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