Narayana Kocherlakota shares his views

  • Updated: December 16, 2009 - 9:48 AM

Narayana Kocherlakota, new president of the Minneapolis Federal Reserve Bank.

Photo: Glen Stubbe, Star Tribune

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Since he was 20 years old, Narayana Kocherlakota has been using complex mathematical tools to solve economic problems. Now at the ripe old age of 46, Kocherlakota is trading in his academic life to run the Federal Reserve Bank of Minneapolis. In 2011, Kocherlakota will become a voting member of the powerful 12-person Federal Open Market Committee, which sets interest rates and guides monetary policy.

Last month, in his first interview since taking the job in September, he sat down with Star Tribune staff writer Chris Serres to share his views on a variety of topics, from his opposition to the Obama administration's stimulus plan to the Federal Reserve's reaction to the financial crisis. He declined to discuss his policy views until he has become more settled in his position.

Q So, the big question is, why did you take the job?

A In the latter part of 2008, it became clear to me that this was a time when my knowledge and skills could be of use, I would say. Now how I could best put them to use I wasn't so sure. I wasn't so sure how to make that transition. Once this opportunity came along, it became clear how to do that.

Q If this was, say, 2003, then would you have agreed to take the position?

A I don't think so. In 2003, I would have said that monetary policy is relatively well understood, we have people in place who know how to do it and they're doing it, and there's really no need to have me involved in that. I think now we're in a situation that's certainly novel, and what we should do next is not so immediately apparent. I think that's where I have more of a role to play.

Q But is this downturn really all that different? There is some debate about whether this recession is just part of the normal business cycle and isn't all different from ones in, say, 1991 or 1981.

A I do not agree with that. I think the linkage to the events in the financial markets is quite different from 1991. The events in the labor markets are quite different, as well, just from a quantitative point of view. We've seen over a 5 percent decline in employment going back to the end of 2007. So just quantitatively, it's much bigger. And I think you see this linkage between the events in the financial markets and housing prices, it just has a very different feel to me than 1991.

Q What do you see as the Fed's biggest challenge? Is it dealing with all these bad loans still on banks' books? Declining asset values? How to prevent the U.S. from becoming like Japan in the 1990s, during the so-called "lost decade"?

A The answer to your question is, 'Yes, sort of.' I mean that I see all these as being very linked kinds of issues. How we confront this situation where, as you say, there's a lot of bad loans on a lot of banks' books, right in the Federal Reserve system, the balance sheet is such that a lot of banks have a lot of excess reserves. We've got interest rates as low as they can go. This is a unique situation. So I'm hard-pressed to say what's the most challenging thing, because I see it all as being one holistic picture that we have to deal with.

Q Last winter you were one of 200 economists who signed a petition opposing President Obama's stimulus plan. Should I assume from this that you are opposed to all stimulus plans, or just the particular one Obama was proposing?

A No, in fact I didn't sign that with a view of being opposed to the stimulus. I viewed signing that as stating my opposition to the idea that we all agree that the stimulus was good.

Q You mean, you were opposed to this assumption that, "we're all Keynesians" now that we're in a severe recession?

A Yes. The idea that there is some kind of uniform agreement among economists that the stimulus was a good thing, or more specifically, would lead to higher output, I didn't view that as being a settled question within the academe.

Q Do you think that Americans perceived economists as unified in their support of the Obama stimulus plan?

A It was certainly characterized in that fashion. That's what I was concerned about. I did not want to have that as the perceived wisdom out there. My signing this was my way of communicating that.

Q Do you think there is a role for a stimulus?

A I think the government has a role to play for public-good provisions in society, so some of the things the stimulus was going to be spent on I thought were natural roles for government. You could very plausibly make an argument that we've let spending on infrastructure go down over time in the United States, and there's a role for building that back up. You could even go further and make an argument that this was a good time to do that. That's a more nuanced argument. It's not obvious that's true. But maybe at a time when there's high unemployment, that this is a good time to be putting people to work on these types of projects. So some of this stimulus spending took that form, and I think that was a good. Some did not.

Q What's an example of something the Obama administration has done, in relation to the stimulus, that you disagreed with?

A In economics, we make a distinction between margin and average. What do we mean by that? So there are two kinds of tax cuts that you can contemplate. One is, we're just going to give you a payment. Say, we'll give everyone $500. My belief is that will not have much of a stimulus effect on output. Basically, if you give a tax credit to people, they recognize the fact that comes out of somewhere. It's not generated out of nothing. In fact, what it's being generated out of is -- taxes! So that transfer that you receive, they're going to recognize that there's a tax that has to be paid to collect that at some point, eventually. You might get some impact by people not fully thinking through that story, but the effect is going to be small. If you were to lower marginal tax rates, that is, cut the taxes on, say, people paying from 30 percent to 29 percent, that's going to be a way to stimulate people to work. And that can have a stimulus effect.

Q But wouldn't I also wonder, if my income tax rate has been cut, that I'll have to pay for that later, too, with higher taxes?

A Yes, but on the margin. There are two effects from this, one is that for every extra hour I spend working, I get to keep more of it. So that's a good thing. But I also get more money in my pocket to spend. But that extra money in my pocket to spend is being offset by future tax collection. I don't think to myself -- and I shouldn't think to myself -- that the future tax collection is going to somehow be related to how much I'm working today, OK? So I still get the benefit of working an extra hour. If they cut my tax from 30 percent to 29 percent, I'm going to get more of an extra benefit than I did before.

Q So is one reason you signed the letter to Obama that you thought a more productive way to deal with the recession would have been a tax cut?

A It depends on what your objectives are, OK? I think if your objectives are to boost employment at that moment in time, then I think cutting taxes would have been a better thing to do. And I should say, specifically, cutting tax rates would have been a better thing to do.

Q You did your graduate work at the University of Chicago, where Milton Friedman once worked and which is known for its free-market orientation. Do you consider yourself anti-government?

A I think what Chicago awoke in me was that government is just a process. There's a political process that leads to decisionmaking. And it's not that the government is bad or that it's good, it's just that it's a product of individuals, and you have to be aware of that. Corporations are also a product of individuals. So saying one is bad and one is good is, which I might have when I was graduating from college at Princeton. I might have said, government good, corporations bad. By the time I left Chicago, I had a much different view, which was, government, as I say, is a collection of individuals working in one way, and corporations are a collection of individuals, and our job is to study them. Yeah.

Q So, do you consider yourself value-neutral as far as the government's role in the economy is concerned?

A I would say I'm trying to approach things with a sense of rigor. I still see myself more as laying out: "If you follow this option, here's what's going to happen. If you follow this option, here's what's going to happen." I think that's what I have to contribute to the process, more than saying, "This option is the best one."

Q You said in a recent interview, before you became Minneapolis Fed president, that you didn't think the Obama administration ever really made the case that we were facing a financial Armageddon.

A That's correct.

Q Do you still think there was a failure to communicate the purpose of the bailout to the American people?

A I think we're still living with that failure. I don't think I'm exaggerating when I say that in Congress, at least, this reflects popular opinion to a certain extent. There are some concerns about what the Federal Reserve did last year in September of 2008. I think that failure to some extent reflects our, now it's going to be on my shoulders as well, to make the case that we were facing a disastrous situation.

Q Looking back on this now, do you think the economic disruption could have been cataclysmic had the government not intervened aggressively?

A "Could have been" is the right term. I think that, had the Fed and the Treasury not pursued the actions that they did, and the FDIC, all these entities working together, had they not pursued the actions they did, we would have faced the probability of an extremely bad outcome. ... I feel much more convinced by the data that's come forward since then. I think we need to do a good job, that's including me now, in putting forth how we forestalled worse things that could have happened, by some of the interventions that we did in September. Not just in September, but in that entire period of late 2007 through 2008.

Q So, the American public needs more information than just, "Trust us, it would have been bad"?

A At the end of September, as an onlooker, as a reader of the newspaper, that's what I felt had been told to me at that point.

Q "Trust us, it would have been bad."

A Correct.

Q What can be done to make the Fed's actions more open and transparent?

A Oh, I think there's a lot that we can do in terms of translating the lessons we've learned from our research into more publicly accessible vehicles. Some of that's been done at the Minneapolis Fed for many years, but there's more that we can do along those lines, and that's something that I want to see us do more of. ... We have a great group of staff economists here. These are people who are just really highly respected within the academe. They're doing great work. We've got to do more to make sure that work is getting known to policymakers and to people in the Ninth District.

Q But is that even necessary? I'm guessing there are some people who might say, "OK, there's a lot of smart people at the Fed," let's just leave it to those smart people to figure these complicated problems.

A Well, the question right now is exactly about that, isn't it? There are questions about whether the Fed did the right thing, for example, in the mid-part of the 2000s, when they kept interest rates that low. Well, you want to have discussions about that, and you want the citizenry to be engaged in that discussion as much as possible. ... So in this period of the 2000s where we've had this sharp decline in asset prices, in stock prices, what should you do in that situation? Well, it doesn't happen all the time. So you have to have a model analyze it. Different models will give you different answers. But it's good for people to see that discussion play out in plain English.

Q Was there anything in particular that you disagreed with in the way the financial rescue was handled -- other than lack of communication?

A I'm going to change your question into something different. Going forward, I hope we have better resolution mechanisms in place for companies like Lehman, companies like AIG, and companies like Bear Stearns. If we do, then I think that will forestall the Federal Reserve from having to engage in direct injections of funds into individual firms. I shouldn't say direct injections of funds, but loans to these individual firms.

Q When you say "resolution," what do you mean?

A A better process for winding them up, so we don't have to think about them taking months and years for that to happen. The role model would be what happens at the FDIC. They're able to close a bank on Friday, depositors don't even notice anything on Monday, and bang, it's open. Their deposits have been transferred to some other institution. If we can get to that with these large complex organizations, that would be fantastic.

Q There's been a lot of talk lately about busting up these big banks like we once did with the trusts. Is that a good idea?

A I'm not convinced of that at all. If you break them up, they're going to form networks among the broken-up pieces. They're going to be hard to follow. Those networks might be even less penetrable than even the current large organizations are. So I'm not convinced that breaking up the financial firms is the right answer at all. In fact, I would go further and say, it doesn't have anything to recommend it.

Q Do you agree that there was a regulatory failure?

A I think it is clear that there are circumstances that the government will be injecting resources into the owners of financial firms, even non-financial firms. We already knew this with the FDIC. So the FDIC is a program where you as the depositor are insured. In some ways, if a bank goes down, you're essentially insulated against the losses that you might otherwise be suffering as a depositor. That's one of the reasons that the government has a role to monitor what the banks are up to.

I think we've seen that the government is on the hook in a similar fashion to claimants, to owners of other financial firms, not just depositors, but debt holders for other kinds of entities. Once you say that's true, they have a role to regulate and monitor what those entities are up to. Once the public has a stake, then we have a job to do, which is to figure out how to modify these firms' behavior.

We don't want it to shut down operations entirely, but we want them to take into account the public stake in the making of their decisions. And how we do that is an important question and an interesting question. I'm not going to get into the question of whether we did the right best possible job in 2006, because that question is only interesting insofar as it helps to inform decision-making in 2010.

Q Earlier this year, you presented a paper at an International Monetary Fund conference in which you appear to be suggesting that the government bail out property owners and raise interest rates. Would you recommend that now as a policymaker?

A I view that paper as an example of my thinking .... To reach conclusions, you write down assumptions, follow them through, and see where the conclusions are. The way to discuss something like that, someone should write down an alternative set of assumptions, which also has a bubble in it, and land prices -- trace through the collapse of the land prices, and see what they should do in the context of that model. And then we can have a discussion about which model is better. So I see that as an example of the kind of rigorous approach I'm going to bring to the policy matters more than anything else.

Q In the study, you talk about the potentially disastrous effects of falling land prices. Can you explain why falling land prices are so disastrous?

A Yes, if the land is being used as a source of collateral, either directly or indirectly, people might be using pieces of paper that are claims to land as a source of collateral, if you're doing that and suddenly the value of that land collapses, suddenly, over a relatively short period of time, then the amount of borrowing capacity has fallen in the country. You're not able to get as much credit off the ground. So that can be very problematic.

Q Is there anything in particular that you think should have been done, could have been done, to have prevented this collapse in property values that we've experienced?

A In the model I describe in the paper, and this part I feel is an accurate description, I don't think there's much that could have been done. In terms of preventing the falling land prices, I don't see that. Rather the paper describes how we should react to that once it happens. And yes, I don't see necessarily any way that we could have stopped land values from falling.

Q What about this idea of issuing government debt to landowners? Is that something that you would actually consider as a real solution?

A As has been pointed out to me, it's actually not that different from proposals that were floated by the McCain campaign and others. It wasn't in terms of injecting government debt. It's very similar to trying to put a floor on land values. In the model, it went to the landowners themselves. Just giving it to the banks would not have helped you, because the banks would not have necessarily lent it out to people that have the projects.

Q Do you think TARP, the U.S. Treasury's plan for injecting more capital into the banks, is a good idea?

A I think it was better than doing nothing. I think there were probably other things that could have been done. What I really liked in terms of the response was, and the problem was, people were operating in a very tight time constraint, so that has to be taken into account immediately. I thought the stress tests in early May; those were wonderful things. It would have been good to do those earlier.

Q Do you see it as a challenge coming into an environment where you're an economist, a theoretician, and you're going to be dealing with a lot of people who may not understand your equations in some of your studies? Are you worried about a language gap?

A First of all, I would question whether I'm a theoretician or not. I actually have a wide range of work, some of it is much more empirical than theoretical. I also think that being a theorist is very valuable. Having some theoretical training and knowledge, which many of my colleagues, I will add, on the FOMC [Federal Open Market Committee, the policy-setting arm of the Federal Reserve] have with me, I think it's very valuable. We're in a situation that we've not really encountered before. If you're in a situation which you've encountered many, many times, you don't need theorists that much, to be honest, because you've got data. If you don't have data, that's when you have to have the theorist coming in.

Q I suppose if you were truly a theorist, and only a theorist, I'd have to bring an interpreter with me.

A [Laughter] It is true that when we develop our economic models we use a particular language, a convenient shortcut among ourselves, and it's important for us to be able to communicate, not just with the other members of the FOMC or the Board of Governors, but with the public at large. And I think we haven't necessarily done a great job of that as academic economists. But that's something that I'm planning to correct, going forward, for myself.

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