Five challenges for Ben Bernanke

When Federal Reserve Chairman Ben Bernanke steps to the lectern Friday in Jackson Hole, Wyo., he’ll have the weight of a struggling economy on his shoulders.

With financial markets sliding and the recovery seemingly on the ropes, Wall Street and the business community will be dialed in to the speech for any signs of a new rescue plan from the central bank.

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Investors are rooting for Bernanke to make a big announcement on plans for stimulating the economy.

But Wall Street isn’t the only audience for the chairman’s address, and he has a number of challenges to consider before deciding whether to “go big” at the Kansas City Fed’s event in Jackson Hole.

1. MANAGING THE SPOTLIGHT

In many ways, the outsized attention paid to Fridays speech has little to do with the Fed — or Bernanke. As the economy teeters, investors are looking for action to boost the economy from any available source. With Congress and the White House deadlocked following the contentious fight over raising the debt limit, the Fed looks to be the only viable option in Washington.

“We’re not going to do effective tax reform in the next year, we’re not going to have a coherent fiscal plan. ... If those things aren’t possible, then the only game in town is the Fed,” said Vincent Reinhart, a scholar at the American Enterprise Institute who previously worked with Bernanke as director of the Fed’s monetary affairs division.

“The Fed’s chief problem is that it’s the only remaining grownup in Washington,” Reinhart said.

The hype for Bernanke’s remarks is also rooted in history. At the same event last year, Bernanke laid the seeds for what would become “QE2,” the Fed’s second crack at boosting the economy by buying hundreds of billions of securities with freshly printed cash.

There is no tradition of big announcements at the Jackson Hole conference, but last year’s speech has sparked more interest in this year’s.

2. DECIDING WHAT TO TELL (OR NOT TELL) MARKETS

Another issue for Bernanke is how much he should play to market expectations.

Investors seem to have convinced themselves that something is in the works at the Fed. After weeks of volatility, the stock market ran up big gains in the first few days of the week in anticipation of Bernanke’s speech.

“The markets rallied the last couple of days because they’re expecting him to make an announcement,” said Lance Roberts, CEO of StreetTalk Advisors.

Bernanke knows the markets are watching Friday’s speech closely, and that a tepid, rehashed statement from him could cause another sharp slide in stocks.

“Markets are tender, Europe is a mess, investors are skittish,” Reinhart said. “It does influence their thinking.”

But at the same time, very few people are expecting Bernanke to come out and announce that help is on the way. For one, Fed chairmen are notoriously vague about their plans, and Bernanke’s speeches usually hew to that tradition.

But a larger reason for Bernanke to be coy is that the central bank’s moves have the greatest impact if the market does not have a chance to price them in ahead of time.

“The Federal Reserve gets the best bang for the buck when the markets are not expecting something,” Roberts said.

With markets anticipating a third round of quantitative easing on the way, the Fed could throw a curveball and consider a different approach, such as capping interest rates or reorienting its portfolio to load up on longer-term securities and try to bring down rates there. Bernanke has also suggested cutting interest paid on bank reserves to nudge that money out into the economy.

3. DEALING WITH DISSENT

While Bernanke serves as the face of the Federal Reserve, he is just one voice of several when it comes to setting policy. The Federal Open Markets Committee (FOMC) sets policy for the central bank via the votes of its 10 members.

The closely watched committee announced on Aug. 9 that it would be keeping interest rates near zero for at least two more years. But three members dissented from the move, the highest level of disagreement on the panel in nearly two decades.

A divided Fed could reduce the effect of its statements, but it could also reflect the fact that Bernanke is getting more exposure than ever.

He has begun delivering regular news conferences following FOMC statements, and Reinhart contends that dissent is the only way for differing opinions to be expressed.

And at the same time, seeing a Fed move forward without a consensus could prove the commitment of the majority.

“In some sense, dissents are liberating because it’s saying, ‘We’re still willing to act,’” Reinhart said.

4. THE GDP WILDCARD

A run of disappointing economic reports have helped drive concern about the nation’s recovery, and it will also be a major factor in spurring the Fed to move.

“They need an outlook bad enough ... that gives them a justification to act,” Reinhart said.

A little more than an hour before Bernanke speaks, the Bureau of Economic Analysis will issue a fresh report on the nation’s economic growth. In July, the government reported the nation’s gross domestic product had grown just 1.3 percent in the second quarter of the year, much less than the 3 percent economists say is needed for strong job growth.

Even more troubling, it also downgraded first-quarter growth from 1.9 percent to just 0.4 percent.

If Friday’s second estimate of second-quarter growth is substantially lower than the original estimate, it could push the Fed closer to action.

“If GDP is really bad in the morning ... you might very well get a direct announcement,” Roberts said.

5. WEATHERING POLITICAL PRESSURE

The Fed is an independent, private institution, theoretically insulated from political pressure. But that doesn’t mean it’s not there.

The Fed has come under increasing fire from Republicans for its quantitative easing efforts, which many conservatives argue is encouraging inflation. Texas Gov. Rick Perry (R) garnered a slew of headlines when he went so far as to say more easing would be near “treasonous.”

But Bernanke may also be under pressure from the other side of the aisle, in the White House, Roberts said. A side effect of pumping money into the economy via easing is that it does appear to boost consumer prices, at least temporarily. And voters feeling the pinch might not be inclined to support the policymakers currently in place.

“On the political front, launching a QE3 ... is not really in the best interest of the current administration,” Roberts said. “There’s a real incentive from a political standpoint to try something different this time.”

It bears noting, however, that Bernanke was originally appointed Fed chairman by then-President George W. Bush, and then reappointed by President Obama.