Greenspan's Conundrum and Bernanke's Nightmare

23 Pages Posted: 7 Apr 2010

See all articles by Francis E. Warnock

Francis E. Warnock

University of Virginia - Darden Business School; National Bureau of Economic Research (NBER)


At what point in the tepid recovery from the global financial crisis should the Fed take a major step in normalizing U.S. monetary policy by greatly reducing its holdings of U.S. Treasury bonds? Federal Reserve Board Chairman Ben Bernanke faced this question in Spring 2012, even as he was concerned that the U.S. economy was on weaker footing than many believed. Suitable for both core and elective MBA courses in global financial markets and international finance, this case examines the risks associated with a policy some would consider monetizing the budget deficit. Students consider the factors behind the current and prospective levels of U.S. long-term interest rates from Bernanke's perspective.



Rev. Mar. 16, 2012

Greenspan's CONUNDRUM and Bernanke's nightmare

Ben Bernanke sat in his office overlooking Constitution Avenue in March 2012 and shook his head. He had just returned from Capitol Hill, where he had presented a briefing on U.S. monetary policy to the Senate Banking Committee. The visit to the Hill was trying, as almost all such visits had been in his five-year tenure as chairman of the Board of Governors of the U.S. Federal Reserve. His term had started out calmly enough in 2006, but the economic downturn quickly morphed into the Global Financial Crisis (GFC) and the Great Recession. For a while, many wondered whether the Great Recession might itself morph into a depression.

But Bernanke, who was a top academic economist before joining the Fed, reacted extremely aggressively to the downturn in growth. Early in his term, in summer 2007, the federal funds (fed funds) rate stood at 5.25%; by the end of 2008, the Federal Open Market Committee (FOMC) had not only lowered the fed funds rate all the way to about 0% but had also begun an almost unfathomable campaign of new facilities to free up frozen credit markets and of credit easing to loosen monetary conditions even further. As the financial crisis went through its worst period—fall 2008 and spring 2009—Bernanke had the Fed purchase over $ 1 trillion in mortgage-backed securities (MBSs) and Treasury securities in an unprecedented expansion of its balance sheet, all to try to stave off a depression. He referred to this as credit easing; the market preferred the term quantitative easing. And then, in August 2010, after the economy had emerged from recession but hit an unexpected soft patch, Bernanke announced that the Fed would embark on the unfathomable squared: QE2, the second round of quantitative easing in which the Fed would become the proud owners of another $ 600 billion in Treasury securities by the second quarter of 2011. Indeed, by some estimates, the Fed had recently surpassed the People's Bank of China as the single largest holder of U.S. Treasury securities.

Bernanke had taken some flak for QE1, but most people saw it as necessary to keep the U.S. economy (and maybe even the global economy) from depression. The reaction to QE2, however, was fundamentally different. Almost immediately, some in Congress called for the abolishment of the Fed. William Gross, the legendary bond investor and head of Pacific Investment Management Co., better known as PIMCO, likened QE2 to a Ponzi scheme:

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Keywords: long-term interest rates, Treasury bond rates, monetary policy

Suggested Citation

Warnock, Francis E., Greenspan's Conundrum and Bernanke's Nightmare. Darden Case No. UVA-BP-0544, Available at SSRN:

Francis E. Warnock (Contact Author)

University of Virginia - Darden Business School ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-6076 (Phone)


National Bureau of Economic Research (NBER) ( email )

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