The week before Neel Kashkari attends a meeting where the nation’s interest rates are set, virtually nothing else matters to the president of the Minneapolis Fed.
Nearly all other work also stops for 10 of the bank’s researchers and economists.
Kashkari and the researchers read hundreds of pages of the latest economic data and meet several times, sometimes for hours, to debate the meaning of the data and their thoughts about how he should vote on the 19-person committee. Sometimes, the researchers take positions they don’t believe, playing devil’s advocate. When Kashkari faces a position counter to what he’s thinking, he unpacks it until he understands its foundation.
“These are like intellectual wrestling matches,” Kashkari said. “They’re wrestling me. They’re wrestling each other. It’s all done in the spirit of ‘Let’s explore this. Let’s unravel these really complex topics.’ I learn a tremendous amount.”
Kashkari became known this year as the most dovish member of the rate-setting panel, called the Federal Open Market Committee, or FOMC. It raised rates three times this year, most recently on Dec. 13, and Kashkari voted against each hike. On two of the votes, he was the only one who did.
At an institution with a reputation and a need for caution, Kashkari is also relatively voluble. Since becoming the Minneapolis bank’s leader early last year, Kashkari has regularly communicated via Twitter and hosted town hall meetings around the Minneapolis bank’s five-state district, taking questions from all comers in both forums.
But he is careful about discussing monetary policy, the movement of interest rates. He found a way to be more open about it by waiting until after FOMC meetings to publish an explanation of his vote and thinking. He produced his latest such essay last Monday and, in an interview later in the week, described how he prepares for the FOMC meetings, which happen every six weeks or so.
No more ‘Wizard of Oz’
Kashkari describes such outreach as his own effort to make the central bank more transparent, building on the work of current Chairwoman Janet Yellen and her predecessor, Ben Bernanke, who routinely held news conferences after FOMC meetings. Bernanke started those comments at the start of the 2008-2009 recession, after he encountered public resistance to some of the difficult and unprecedented measures the Federal Reserve wanted to take to fend off a depression.
“Historically, the Fed had adopted this Wizard of Oz routine: That monetary policy is really complicated. Don’t ask. It’s confusing. Just leave us alone,” Kashkari said. “When the crisis hit, we needed the public’s trust because we were doing extraordinary things, but we hadn’t earned the trust. We’re still trying to dig out of that.”
Since the start of central banking two centuries ago, there have been people who resisted the concept. Kashkari and other Fed officials even today routinely encounter critics who perceive the Federal Reserve to be an opaque institution whose interests clash with their own.
Despite steps at greater transparency, Fed officials still debate and set interest rates — essentially determining the cost of money in the United States and influencing similar decisions at central banks around the world — behind closed doors. The central bank releases minutes from the two-day FOMC meetings about a month after they occur, a disclosure that sometimes affects stock and bond prices. The bank waits five years to release a transcript from an FOMC meeting.
Kashkari said his preparations center around reading the volumes of data prepared by Fed staffers in Washington and Minneapolis and discussing it all with the local bank’s researchers.
Mark Wright, research director at the Minneapolis Fed, said the staff pays continuous attention to the emergence of economic data from many sources but goes into “high gear” the week before an FOMC meeting.
“We’re working in a world of uncertainty, where our understanding of the economy is as good as it can be, but it’s still imperfect,” Wright said. “We’re all motivated by the same thing, which is to get to the truth as much as we can and give the best policy advice that we can so that Neel is as prepared as possible when he goes to the meeting.”
Volcker’s inflation miracle
Late last year, when it was clear to Kashkari that the FOMC would undertake a series of rate hikes in 2017, he asked Wright and the other economists to do some extra work by taking a look at the history of every previous period of rate hikes since the modern Fed started a century ago. The group looked at the thought processes of the people involved in the decisions, the information those people had at the time, and the information we now have on those periods.
And they made a discovery that provided a foundation for Kashkari’s resistance to raising rates this past year: the curtailing of inflation by the Fed under Paul Volcker in the early 1980s led Americans to believe the central bank can always keep it under control.
“The big change is the role of inflation expectations in the inflation process,” Kashkari said. “The Volcker miracle was anchoring inflation expectations and giving people confidence the Federal Reserve was going to be independent of politics and be a strong inflation fighter.”
The rate-setters on the FOMC have been trying to figure out how to react to a U.S. economy that is behaving in violation of economic theory. In setting rates, the panel looks at two main variables, inflation and unemployment, under a theory that says those conditions have a stable and inverse relationship. Low unemployment correlates with high inflation and vice versa. The relationship is expressed mathematically and graphically by what’s known as the Phillips curve.
But the U.S., along with other developed countries, for a few years has had low unemployment and low inflation. Kashkari all year has said he believes that the job market is not as strong as the unemployment data suggests and said the fact that Americans expect inflation to be low is one reason that it is.
When he travels the five states that the Minneapolis Fed oversees, he asks business owners about raising prices and routinely hears they won’t or can’t. “That is the expression of low inflation expectations,” he said.
In his first dissent of a rate hike in March, Kashkari noted that the inflation rate had not hit the target rate of 2 percent that has long been considered by the FOMC as a target for a balanced U.S. economy. Over the course of the year, the rate of inflation actually slowed.
“I was surprised that inflation ended up turning down,” Kashkari said. “What surprised me even more was that my [FOMC] colleagues did not find the falling inflation persuasive.”
Wright said the Minneapolis Fed researchers dug hard into the period before Volcker began to concentrate on controlling inflation. In the years that followed, Volcker and the central bank faced criticism for not tackling inflation earlier.
“We were trying to make sure there’s no chance of repeating those errors,” Wright said. “We came away concerned that the Fed has the potential of making the opposite error. Instead of being slow to react in allowing inflation to take off, we are being perhaps too quick to react in allowing it to slip.”
The chief way for the Fed to control inflation is to raise rates, which makes it more costly for businesses and individuals to borrow money and generally slows the economy.
Kashkari said that the research department at the Minneapolis Fed is filled with independent thinkers, and that he took responsibility for the ultimate decisions to oppose rate hikes. Still, he added, “I could not have taken the positions I have taken or had the confidence to take the positions that I have taken without having such a strong research staff here.”
A new ‘controversial’ idea
After this month’s meeting, Kashkari expressed a new reason not to raise rates: the possibility that the bond market was inching to a pre-recession signal. Recessions are a time when the FOMC typically cuts rates to stimulate the economy.
In the interview, he noted that the bond market’s yield curve signal looked less perilous later in the week. He said he expects more clarity on it over the next few months.
Kashkari won’t have a vote on interest rates in 2018 or 2019, though he will still attend FOMC meetings and express his views. He said he will look for appropriate moments during the year to disclose his thinking publicly but isn’t sure precisely when that may be.
At the moment, he has been thinking a lot about another idea he calls “somewhat controversial.” He said he is starting to believe that the Federal Reserve has a bigger role to play driving the job market than is conventionally thought. He said the extraordinary efforts some employers are taking to get workers these days is bigger than any government program to train them could be.
“My takeaway from that is fiscal policy has a role to play but monetary policy has a huge role to play,” Kashkari said. “If we can keep the expansion going and keep the job market strong, all of a sudden we’re going to be bringing lots of people into the workforce who otherwise haven’t been able to participate.”
But there’s a difficult counterpoint: The last people hired in an upturn tend to be the first fired in a downturn.
“Nobody can promise the Fed is going to end economic cycles,” he said. “We’re not. That’s the limit of that idea.”