This paper discusses five questions the incoming chairman of the Federal Reserve must ponder as he assumes his new post. How important are monetary rules? Should the Fed adopt inflation targeting? Should he be free with his opinions? Should he be a high-profile public figure? Is it more important to be good or lucky?

N. Gregory Mankiw

English

Research Papers in Economics

 
       H H   I I   E E   R R 
 
Harvard Institute of Economic Research 
 
Discussion Paper Number 2110 
 
A Letter to Ben Bernanke 
 
by 
 
N. Gregory Mankiw 
 
February 2006 
 
HARVARD UNIVERSITY 
Cambridge, Massachusetts 
 
 
This paper can be downloaded without charge from: 
http://post.economics.harvard.edu/hier/2006papers/2006list.html 
 
The Social Science Research Network Electronic Paper Collection: 
http://ssrn.com/abstract=884223 
  
A Letter to Ben Bernanke 
N. Gregory Mankiw 
 
Professor of Economics 
Harvard University 
December 2005 
 
 
 
 
 
 
This paper was prepared for the meetings of the American Economic Association, 
January 2006, in a session titled “Alan Greenspan’s Legacy: An Early Look.”   
 
 
 
 
 
 
 
   1
Abstract: This paper discusses five questions the incoming chairman of the Federal 
Reserve must ponder as he assumes his new post. How important are monetary rules?  
Should the Fed adopt inflation targeting? Should he be free with his opinions? Should he 
be a high-profile public figure? Is it more important to be good or lucky? 
 
 
N. Gregory Mankiw 
Harvard University 
Department of Economics 
223 Littauer Center 
1805 Cambridge Street 
 Cambridge, MA 02138  
ngmankiw@harvard.edu 
phone: 617-495-4301 
fax: 617-495-7730, address:  
 
 
 
 
 
 
 
   2
A Letter to Ben Bernanke 
By N. Gregory Mankiw* 
 
Dear Ben, 
  Congratulations on your appointment to become new Chairman of the Federal 
Reserve.  I am delighted both for you and for the nation.  President Bush could not have 
made a better choice. 
  Of course, you have big shoes to fill.   Alan Greenspan is widely acknowledged to 
have been a superb Fed chairman.  Alan Blinder and Ricardo Reis (2005) may even prove 
right in their judgment of Greenspan as “the greatest central banker who ever lived.”  His 
tenure exhibited low and stable inflation, as well as robust and stable growth in 
production and employment.  There is little more that we could ask of a Fed chairman. 
  But there is little point now to you or I heaping praise on Greenspan.  Most 
activities run into diminishing returns.  Given all the praise that Greenspan’s been getting 
lately, the marginal utility of one more accolade must be close to zero.    
  There are, however, several intriguing issues that the Greenspan legacy raises.  In 
my mind, there are at least five questions that monetary economists, economic historians, 
and future Fed chairmen (this means you, Ben) will need to ponder as they decide what 
lessons to learn from the Greenspan era. 
 
 How important are monetary rules?  
  As you know, over the past twenty years, academic economists have been 
fascinated with monetary rules.  A widespread consensus has developed that we need to   3
think about monetary policy not as a series of discretionary policy actions but, instead, as 
the implementation of a systematic rule.  As Finn Kydland and Edward Prescott (1977) 
showed so forcefully, monetary policy set by discretion is tempted to be time-
inconsistent, leading to more inflation than is optimal.  That is why so many academic 
macroeconomists now believe that monetary policymakers should tie their hands and 
commit to some sort of policy rule. 
  Greenspan’s success provides a real challenge to this widespread view.  As you 
know, Greenspan has long been skeptical of policy rules.  He knows that the future will 
ask central bankers to deal with events that they cannot now imagine.  In light of this 
Knightian uncertainty, Greenspan values flexibility as a higher priority than commitment. 
  So now you must ask yourself: Which position do you believe?  Are you going to 
follow the prescription of the academic literature and look for ways to tie yourself to the 
mast, as Odysseus did and as Kydland and Prescott would recommend.  Or are you going 
to follow in the footsteps of “the greatest central banker who ever lived?”  This is closely 
related to my next question. 
 
 Should the Fed adopt inflation targeting? 
  I know, Ben, that you have long advocated inflation targeting, under which a 
central bank sets a numerical target for the inflation rate.  You will soon be in a position 
to put your monetary policy where your mouth is. 
  This will not necessarily be easy.  Inflation targeting has worked well in other 
countries, and it is supported by many U.S. economists, but the support is not universal.  
As you know, Alan Greenspan has long been a skeptic.  More important, so is   4
Greenspan’s close protégé Donald Kohn, who remains a member of the Federal Reserve 
Board of Governors and commands broad respect among the other members and the Fed 
staff.   
Some recent news reports have suggested that inflation targeting would mean a 
big change in policy from the Greenspan era.  You and I know that is not right.  We know 
that inflation targeting is not a hard-core policy rule.  It would leave you with a 
substantial amount of the short-run discretion that Greenspan values so highly. 
Starting where we are today, a switch to inflation targeting is not so much a 
change in monetary policy as it is a change in the way the Fed communicates about 
monetary policy.  To a large extent, Greenspan’s policy can be described as “covert 
inflation targeting.”  Greenspan has never announced a commitment to any particular 
target inflation rate, because he wants to maintain maximal flexibility, but there is little 
doubt about his goals.  As former Fed governor Laurence Meyer has pointed out, anyone 
who doesn’t know that Greenspan is aiming for a measured inflation rate of about 1 to 2 
percent is just not paying attention. 
The evolution toward your vision of inflation targeting can, therefore, be very 
gradual.  This would be consistent with your pledge to continue the policy of the 
Greenspan era, and it would ease the minds of skeptics like Kohn.  Over time, your 
speeches and the Fed policy statements can make increasing reference to medium-term 
inflation forecasts and whether they are deviating from desirable levels.  The financial 
world will start seeing monetary policy through the lens of inflation-targeting, even if you 
never offer a grand announcement of a new regime. 
   5
 Should you be free with your opinions? 
  Greenspan has, over the years, not been shy about expressing opinions on a broad 
range of economic issues.  This proclivity has at times made some Fed staff cringe.  The 
political independence of the Fed is one of institution’s most valued features.  That 
independence was created by Congress, and it can be taken away by Congress. Whenever 
the Fed chairman ventures off the reservation and opines on a politically charged topic, 
he puts the Fed’s independence at risk.   
  Yet the issue is far from one-sided.  Although Fed staff would prefer that the 
chairman stay silent on issues not directly relevant to monetary policy, doing so would 
entail a significant cost.   Greenspan has offered intelligent analysis of many economic 
issues that are vital to the nation.  If the Fed chairman refrained from offering his views, 
someone less knowledgeable would fill the void. 
  One of the big questions you must decide for yourself, Ben, is how far you are 
willing to go.  Although as an economist you are just as broadly insightful as Greenspan, 
you will not inherit Greenspan’s political credibility.  This should make you more 
circumspect, at least initially. 
  Here are my suggestions about how far you should go.  You should be prepared to 
talk not only about monetary policy but also about issues related to financial stability.  
Regulation of Fannie Mae and Freddie Mac, for example, is a tremendously important 
issue.  During my two years in Washington, I saw Greenspan play a central role in 
pushing policy toward these institutions in the right direction.  You should do the same. 
  You should be willing to explain the views of professional economists when there 
is a consensus.  For example, like Greenspan, you should remind us about the benefits of   6
free trade when the protectionists in Congress get restless—which they do often.  You 
should not hesitate to remind Congress about the impending fiscal problems that will 
arise when the baby-boom generation retires and starts collecting Social Security and 
Medicare.  The economics profession is pretty sure that the government has to live within 
its present-value budget constraint, even if Congress likes to pretend otherwise. 
  But you should stay away from issues that have a trifecta of problems—those that 
are distant from monetary policy, controversial among economists, and politically 
divisive.  The repeal of the estate tax, for instance, is not an issue that you should 
comment on anytime soon.  Most social issues and foreign policy fall into the same 
category. 
 
 Should you be a high-profile public figure? 
  Alan Greenspan is a rock star, at least by the standards of American Economic 
Association.  So high has his profile been that I am surprised that we have not yet seen a 
TV drama written around the life of a central banker.  Much of the general public may 
fail to understand what monetary policy is, but they know that it is important, and that 
Greenspan is the man.   That is why the choice of Greenspan’s successor was awaited 
with such anticipation. 
  You and I know, of course, that that monetary policy is set not by a single person 
but by a large committee supported by one of the most talented staffs of professional 
economists working in government.  If you as the new Fed chairman accept a lower 
public profile than Greenspan had, the true nature of the Fed could be more widely 
appreciated, and that would be step in the right direction.  Monetary policy is not so   7
complex that we need an inscrutable wizard to do it well.  A group of competent, well-
meaning, hard-working public servants can do it just fine. 
  My recommendation to you is to become as boring a public figure as possible.  
For an economist, boring is an occupational hazard.  For a central banker, however, it is 
just the ticket.  The central bank’s job is to create stability, not excitement.  One way of 
doing that is to increase confidence in the institution of the Federal Reserve and to 
educate the public that the institution matters more than the individual who happens to be 
leading it at the moment.  It would be ideal if, after a long, successful tenure, your 
retirement as Fed chairman were a less momentous event than your arrival.   
 
 Is it more important to be good or lucky?   
  If you were to poll monetary historians, most of them would tell you that Alan 
Greenspan is a hero among central bankers and that Arthur Burns is a goat.  Just as 
Greenspan gave us low and stable inflation, together with robust and stable growth, 
Burns gave us high and rising inflation, together with anemic and volatile growth.  The 
standard assessment of these two men is easy to understand. 
  Yet, in looking back at these polar two experiences, I wonder whether we 
exaggerate the role of policy decisions and understate of role of luck.  One reason is that 
the bad inflation performance of the 1970s and the good inflation performance of the 
1990s were not limited to the United States.  Most developed countries had about the 
same experience.  If there was a policy failure in the 1970s and success in the 1990s, the 
blame and credit go to the world community of central bankers, not to the single person 
leading the Federal Reserve.   8
  I suspect, however, that the difference cannot be fully explained by policy at all.  
These two eras saw very different exogenous supply shocks.  The relative price of food 
and energy was extraordinarily volatile during the 1970s and extraordinarily tame during 
the 1990s.   The standard deviation of this relative price differs in these two decades by a 
factor of almost three. (Table 1.3, Mankiw 2002)  Moreover, the 1970s witnessed an 
unexpected slowdown in productivity growth and an increase in the natural rate of 
unemployment, whereas the 1990s witnessed an unexpected acceleration in productivity 
growth and a decline in the natural rate of unemployment.  The favorable supply-side 
developments of the 1990s were not caused by monetary policy, but they did make the 
job of monetary policymakers a lot easier.  Luck plays a large role in how history judges 
central bankers. 
  So, Ben, I wish you the best of luck in your new job.  You may well need it! 
 
Sincerely, 
Greg Mankiw 
 
P.S. I will miss seeing you as regularly at conferences, but I must admit that I will not 
miss you as a competitor in the textbook market.  9
 
References 
 
Alan S. Blinder and Ricardo Reis, “Understanding the Greenspan Standard,” Princeton 
University, paper presented at Federal Reserve Bank of Kansas City conference at 
Jackson Hole, 2005. 
 
Finn E. Kydland and Edward C. Prescott, “Rules Rather Than Discretion: The Inconsistency 
of Optimal Plans,” Journal of Political Economy 85 (June 1977): 473-492. 
 
N. Gregory Mankiw, “U.S. Monetary Policy During the 1990s,” American Economic 
Policy in the 1990s, eds. Jeffrey A. Frankel and Peter Orszag, MIT Press, 2002. 
 
 
 
 
 

Rules Rather Than Discretion: The Inconsistency of Optimal Plans,”

Understanding the Greenspan Standard,” Princeton University, paper presented at Federal Reserve Bank of Kansas City conference at Jackson Hole,

A Letter to Ben Bernanke

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A Letter to Ben Bernanke

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