Who Should Safeguard Financial Stability?

George W. Bush won the 2000 election, despite losing the popular vote. In 2003, Bush chose as his Treasury secretary John W. Snow, a railroad president who, as Barron’s columnist Alan Abelson put it, may not be the sharpest knife in the cabinet. Snow obliged the president and gave unquestioning support to his policies until leaving office in 2006, just before the crisis erupted. Under the new law, Snow would have been in charge of the stability of the entire US economy.

One theme that Bush found resonated with voters in his 2004 re-election campaign was that of the ownership society. A successful economy, Bush argued, requires that people learn to take responsibility for their actions, and policies aimed at boosting home ownership would inculcate this virtue on a broader scale. That sounded right to voters, especially if it meant government policies that encouraged the emerging real-estate bubble and made their investments in homes soar in value.

Snow echoed his boss. The American economy is coiled like a spring and ready to go, he chirped in 2003. Two years later, near the very height of the bubbles in the equity and housing markets, he declared that, We can be pleased that the economy is on a good and sustainable path.

But, to Bush’s credit, he also brought in Ben Bernanke in 2006 as Fed Chairman. Not part of Bush’s team, Bernanke was protected from political pressures by America’s long tradition of respect for the Fed’s independence. The choice of Bernanke, an accomplished scholar, apparently reflected Bush’s acceptance of the public’s expectation of a first-rate appointee.

The same problems occur in many other countries. People who are chosen in part to win the next election often find their economic judgment constrained. A news story in 2003 reported, for example, that Australian Secretary to the Treasury Ken Henry had warned of a housing bubble there, but then quickly tried to withdraw his comment, saying that it was not for quotation outside of this room. He did earlier this year finally propose new tax policy to slow the still-continuing Australian housing bubble, but now he can’t get his government to implement it.

By contrast, in recent decades central bankers in many countries have gradually won acceptance for the principle of independence from day-to-day political pressures. The public in much of the world now understands that central bankers will be allowed to do their work without interference from politicians. There is a tradition of the central banker as a worldly philosopher, who stands up for long-term sensible policy, and this tradition makes it politically easier for central bankers to do the right thing.

In fact, while the world’s central banks did not see the current crisis coming and did not take steps before 2007 to relieve the pressures that led to it, they did react decisively and energetically as the crisis unfolded, with coordinated international action. This was facilitated by the tradition of political independence and cooperation that has developed over the years among central bankers.

The crisis has underscored the utmost importance of macro-prudential regulation. Although our central bankers are not perfect judges of financial stability, they are still the people who are in the best political and institutional position to ensure it.

Robert Shiller, Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.

Copyright: Project Syndicate, 2010.www.project-syndicate.orgFor a podcast of this commentary in English, please use this link:

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