The Fed's new deep bench: several new Federal Reserve policymakers are making surprisingly important contributions to the inside debate. TIE interviews one of the leaders, Governor Ben Bernanke.

• Position: United States

TIE: Let's start out with the U.S. economy. There seem to be two views: One says that if you pull back the tarp--the tarp being geopolitical uncertainties post-Iraq--you have a pretty favorable picture. It's not perfect, but a 4 percent-plus potential growth rate is not unexpected given low interest rates and likely fiscal stimulus. The other view, as offered by firms such as Goldman Sachs, is that once you pull back the tarp, this economy is still pretty ugly, with a lot of problems in the world. This view says that the corporate CEO crowd was faking it, that geopolitical uncertainties are not the real reasons we're not taking risks. Some drag is coming from the state and local deficits. We have problems on Federal debt, not to mention other long-term concerns in a post-bubble economy. Where do you see things going post-Iraq?

BERNANKE: First of all, I don't think that it is quite so clean as pulling the tarp back. There are plenty of geopolitical scenarios with various residual issues, such as terrorism, rebuilding Iraq, and other ongoing concerns. The experiment's never going to be that clean. Having said that, I would fall into the former camp, viewing the economy as fundamentally strong. Some of the positives are strong productivity growth, basically good financial conditions, a resilient and flexible structure, and technological leadership. If you look back at the last couple of years, the economy was hit not only by a big decline in stock prices and major problems in a number of sectors, but also by September 11 and a variety of other shocks including the accounting scandals, and despite that we had nearly 3 percent growth last year. I think that it's a safe bet we'll have 3 percent growth this year even with all that's going on. Also, there's a very good chance that after almost three years of not investing and not hiring, and squeezing more and more output out of more or less the same amount of capital and labor, firms are going to have to increase hiring and investment. Put all those things together with a reduction in geopolitical uncertainty and it doesn't take a great deal of imagination to see 4 percent-plus growth later this year and into 2004. The negative possibilities are continued nagging problems from the world situation. The more amorphous possibility is a kind of ongoing self-confirming pessimism such that people are afraid to invest because people are afraid to invest. But again, when you compare the United States to other major industrial countries, it's very hard to point to deep-seated financial and structural problems in this economy. It seems like an economy that has had some setbacks but is basically in remarkably good shape considering the events of the last few years.

TIE: So far the consumer has been the hero, holding things up impressively. The corporate decision-making community has held back. CEOs haven't really appreciated the degree to which inflation has come down. Is there a problem with the convergence of real and nominal rates now, given that the corporate community has not really experienced an environment in which they didn't have a 3-4 percent inflationary cushion? Is there going to be a problem with pricing power in a price-stable world, and is the convergence of real and nominal interest rates going to complicate the ability of the non-consumer part of the economy to take off?

BERNANKE: It's remarkable that households have gotten used to a price-stable world, yet sophisticated CEOs haven't figured out money illusion yet. Profits are still being driven by very slow increases in unit costs, weak nominal wage increases, and strong productivity increases, even if revenues are growing slowly. Real profitability is ultimately what matters. I remember twenty-five years ago there was a great deal of academic literature on why inflation seemed to be so bad for the stock market. At the time the view was that people didn't understand the difference between real and nominal interest rates; high inflation was bad for the stock market because people were comparing stock returns to high nominal interest rates, and with nominal interest rates high, people wanted to hold bonds instead of stocks. So high inflation is bad for stocks and low inflation is bad for stocks. Ultimately people get used to the inflation environment, and we're better off in a world where prices are more or less stable so you can use dollar measures to compare prices across space and over time. It's also a better environment when firms see they have to make profits by...