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How the Fed Chief Gains Credibility

Tuesday, June 13, 2006 | 06:00 AM

One of the best things about doing TV is who you bump into back stage or the green room. On Thursday's K&C show, I ran into CNBC's Chief Economist, Steve Liesman in makeup (I've chatted up Steve before from doing Squawkbox).

We started discussing markets and the Fed. Steve explained the current situation using a biblical parable -- the tale of Abraham and Isaac. I told him this was a wondeful parable, and offered him the Big Picture as a platform to publish it.

He agreed, and so without further adieu, here is Steve Liesman's explanation of how a new Fed Chair gains anti-inflation credibility -- by his willingness to sacrifice his only son, the economy:

How the Fed Chief Gains Credibility
a biblical tale of credibility and faith
by Steve Liesman

"We throw this idea around a lot, but we talk little about it. The usual idea is that he shows this by raising interest rates to fight inflation. But I think the idea goes deeper. What markets want to know, what makes them sleep at night and not fret about inflation, what the real reason behind the Greenspan and Volker Puts is this: at the end of the day, the Fed Chairman is willing to sacrifice economic growth to fight inflation, to take on the body politic and risk his popularity in that fight and to cause a recession if needed.

This may sound absurd (but might not be in the context of Bernanke), but think of the Biblical story of Abraham and Isaac. Only by showing that he was willing to sacrifice his son could Abraham prove the credibility of his faith. This is the test that markets are putting Bernanke through.

Note, he doesn't have to cause a recession, just make markets believe 100% that he will to fight inflation. And I mean 100%. There is no wiggle room.

David Rosenberg of Merrill Lynch said this: If we see a rate hike after the raft of soft data posted in recent weeks, then we can only draw the conclusion that in the name of rebuilding anti-inflation credibility, the central bank is willing to sacrifice the economy.

In fact, I believe that is the only way to rebuild anti-inflation credibility. I would add that Bernanke would have faced this test whether or not he talked to Maria. Greenspan, remember, is blamed for ruining Bush I's reelection chances. Volker caused a recession. Of course, we're talking about inflaton being at a very low level now. But that's balanced by the fact that the additional amount Bernanke has to tighten to gain credibility is much lower than the hurdle that Volker faced.

Note that we can now make an economic assessment. Is 25 or 50 basis points of additional tightening, and the increased economic drag it will cause, worth the value we'll get from a chairman who has the market's confidence? I'd say that every additional year that he remains in office, the less the cost of that additional tightening."

-Steve Liesman
Senior Economics Reporter, CNBC