Bernanke warns of risks of shadow banking, strong dollar and war for financial stability

Ben Bernanke unveiled his newly awarded Nobel Prize on Monday at a meeting with the press at the Brookings Institution, the think tank in Washington for which he works. The former president of the Federal Reserve has assured that the prize had caught him by surprise and has been delighted to share it with the professor of the University of Chicago Douglas W. Diamond, and with Philip H. Dybvig, of the Washington University of St. Louis (Missouri). Bernanke has not shied away from questions about the current situation. He sees the most solid banking to avoid a financial crisis, but he asks to pay attention to the risks derived from shadow banking, the strength of the dollar and the impact of the war in Ukraine.

The winner maintains that, although the banks are better capitalized, a persistent economic crisis can lead to a financial one and feed back. “Even if financial problems don’t start an episode, over time, if the episode worsens financial conditions, they can exacerbate the problem and escalate it, so that’s something I think we need to pay close attention to,” he said.

“Of course, we are not in anything like the serious situation we were in 14 years ago”, he conceded, although he has drawn special attention to European financial institutions, especially due to the impact of the war in Ukraine, and on the of emerging countries, because “they face a very strong dollar and a large number of capital outflows”, as he explained.

From the theory to the practice

The study of the relationship between financial and economic crises, with a special academic focus on the Great Depression of the 1930s, is what has earned Bernanke the Nobel Prize, so he is an authority on the subject.

After reviewing his academic work, he joked about how he went from the muses to the theater: “Of course, you already know that a scientist must make real-world applications of his ideas and so since 2008 I was involved in a financial crisis where problems in the financial sector cause tremendous problems in the real economy, both here and around the world.”

When house prices began to fall in 2007 and 2008, Bernanke was slow to realize the enormous impact that this was going to have on the financial sector and the economy in general. Later, however, he used all his knowledge and decision to avoid an economic depression and fall into a deflationary spiral, using all the weapons that monetary policy put at his disposal. Few economists like him have been able to take his thesis from theory to practice.

Inflation and deflation

He lowered interest rates and flooded the market with liquidity, in addition to advocating the rescue of financial entities with problems. Now the problem is not the risk of deflation, but inflation, which the Federal Reserve is fighting with the most aggressive interest rate hikes since the 1980s, something it has approached from a generic perspective. “Interest rates are much higher than they were a few years ago, that’s for sure. But on a historical basis, they are not that high. Real and underlying long-term interest rates are still quite low,” she said.

“A very good question is where will interest rates be in the very long run. I don’t pretend to know, but I think that over time inflation will come down and the economy will rebalance. And when that happens, I think we will see lower interest rates, maybe not as low as before the pandemic, but I think we will see relatively low interest rates in the future”, he added.

Bernanke also devoted some of his academic work to stressing the importance of inflation targeting. The economist highlights them as part of the communication process. “One of the things that happened during my tenure at the Fed was that we became much more transparent, much more open in trying to explain what we’re doing. And the inflation targets were a part of that, rather than the actual numbers.”

On whether the current 2% target should be revised upwards, he explained that it is a medium-term target that does not have to be met all the time, but rather the speed with which it must be met in each case must be calibrated. That said, at the current time, “changing the target in the midst of a situation where inflation is well above target would not be good for the Fed’s credibility overall.”

The great challenge of the current president of the Federal Reserve, Jerome Powell, is to try to achieve a soft landing for the United States economy, that is, to control inflation without causing a recession with restrictive monetary policy, something that Powell himself sees as harder every time. Bernanke replied: “It is a very difficult challenge for the Federal Reserve, but I have a lot of confidence in our colleagues to overcome it again.”

Bernanke has been asked what advice he would give to a young economist who has been inspired by his work. “One of the lessons of my life is that you never know what is going to happen,” he replied. “It’s random, in the sense that you get a shot here and a shot there. So I guess my advice to the recent college graduate is for him to cultivate his learning abilities, not to plan too much, not to think he knows where he’s going to be in 20 years, because he doesn’t. That he has a broad set of experiences, a broad set of skills, that he works with a lot of different people. Those are the things that will make you flexible, and able to address or deal with changes in everything that happens in our economy and our society”, he has concluded.

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