Bernanke must work to improve confidence

WASHINGTON — Now that the Senate has confirmed him for a second term as chairman of the Federal Reserve, Ben Bernanke has, or ought to have, a very simple agenda: Improve confidence. This isn't his job alone, of course. President Barack Obama and Treasury Secretary Timothy Geithner are hardly bit players. But what Bernanke does and says — how he projects himself and the Fed — matters a great deal, and he faces an exacting challenge.

There is a supposition among academic economists (the tribe from which Bernanke comes) that "economic policy" consists of making decisions about interest rates, taxes, government spending and regulations that translate, almost mechanically, into actions by firms and consumers to hire or fire, spend or save, invest or hoard. By now, Bernanke surely recognizes that this economic model is at best a half-truth.

The famous British economist John Maynard Keynes (1883-1946) coined the phrase "animal spirits." Less elegantly, we say "emotions." Whatever the vocabulary, the lesson is the same: Psychology matters. Booms proceed from overconfidence; busts inspire great fear. Recoveries require increasing optimism. Otherwise, despondent consumers confine buying to necessities, and businesses delay hiring and expansion.

By many measures, confidence has already improved. At the depth of the crisis in October 2008, 73 percent of Americans rated the economy "poor" and 84 percent thought it was "getting worse," according to Gallup surveys; recent responses in mid-January were 47 percent and 58 percent — dismal but better. Interest rates on many bonds have dropped sharply. In October 2008, high-quality corporate bonds fetched 9.5 percent; now, that's about 6.2 percent. Lenders have become less risk-averse; credit markets, though damaged, are working better.

Still, confidence remains fragile, for obvious reasons. Unemployment is 10 percent and may stay high for years. The Congressional Budget Office's latest outlook has it averaging 10.1 percent this year, 9.5 percent in 2011 and 8 percent in 2012. Against that backdrop, Bernanke's confidence-building mission faces two problems.