Donald Kohn on the Fed’s Past, Present, and Future

Donald Kohn is a 40-year veteran of the Federal Reserve System and a senior fellow in the Economic Studies program at the Brookings Institution. Don returns to the program to discuss the lessons of the Greenspan Fed, how Kevin Warsh should think about communication and forward guidance, why inflation remains a concern, the Fed’s new task forces, the future of its monetary policy tools, and much more.

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This episode was recorded on July 22nd, 2026

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us. 

Our guest today is Donald Kohn. Don is a 40-year veteran of the Federal Reserve System and a senior fellow at Brookings Institution. He joins us today to discuss recent developments at the Fed, as well as his reflections on Alan Greenspan. Don, welcome back to the program.

Donald Kohn: Great to be with you again, David.

Beckworth: It’s great to have you here. As I mentioned, you’re a 40-year veteran. You previously were on the show, and I listened to it recently, preparing for this one, and it’s a fantastic episode. I encourage all the listeners out there to go back and check it out. We spent a lot of time on your career. Among other things, we talked about how you actually started at the Kansas City Fed from 1970 to ’75.

Kohn: That’s right.

Beckworth: One of my colleagues here, Tom Hoenig, was one of your colleagues—

Kohn: Oh, yes.

Beckworth: —back in the day. 

Kohn: We had a basketball game after work on the ninth floor, I think it was. Tom claims I injured him with an elbow in his ribs or something once. We were colleagues there.

Working with Paul Volcker

Beckworth: That is awesome. Then you guys, of course, met again at the FOMC when he became president and came back. You guys continued to be colleagues, and you had fun. What a great story. Then you go to the Board of Governors as a staffer in 1975, as you tell on the podcast. Again, I encourage listeners to check it out because you tell fascinating details about your time working with Arthur Burns, Paul Volcker, Alan Greenspan. We’re going to spend some time on Alan Greenspan today. You worked with all of those individuals. You also worked with Ben Bernanke. He’s now your colleague as well. You have a rich story, and I look forward to your biography that you’re writing when it comes out, Don. It’s going to be a lot of fun to read. 

I just wanted to mention one story that you told last time that during the Paul Volcker years, when unemployment was double-digit and you were fighting the good fight that had to be fought to bring inflation down, you mentioned a story that some advocacy groups came to the Board of Governors. Paul Volcker went out to meet them. Really, he started what would be considered, I think, the first listening tour. You were sent on the listening tour. You mentioned that you went to Seattle to a room, and you were accosted by people there who were hostile. When you got back, what did Paul Volcker give you?

Kohn: He had staff and governors go out to various sites, various locations around the country that this consumer advocacy group had invited us to. He gave everybody who appeared and was subject to this hostility a Purple Heart.

Beckworth: Purple Heart, okay.

Kohn: I wish I had saved it. 

Beckworth: You don’t have it.

Kohn: I had it for a long time, and I don’t know what happened in one move or another. Then they came into the Federal Reserve Board after they were finished and met with the Federal Reserve Board, including Paul Volcker. They started yelling at him too. I must admit, I sat there thinking, “That’s okay. Now you know what we went through. You get a sense of it.” I think Mike Bradfield, who was the general counsel, actually gave him a Purple Heart also after this was over.

Beckworth: Purple Hearts all the way around at the Board of Governors. That was an intense time, as you mentioned last time. It was something that took a spine for Paul Volcker to get through.

Kohn: Absolutely.

Beckworth: He was not only accosted by this consumer advocacy group, but Congress. You mentioned there was an impeachment possibility for him during that time.

Kohn: That was never a serious one. Yes, somebody, I think it was Henry González in the House of Representatives, introduced a petition or whatever, impeachment. Yes, it was very serious and very difficult. The lesson learned here is you’ve got to stick to it. You’ve got to keep your focus. Certainly, Paul Volcker was very focused on price stability and breaking the back, particularly of the inflation expectations and the repeated rounds.

I think another lesson was one reason that the Fed, under Arthur Burns, didn’t take the steps necessary was they were afraid of the cost. They were afraid that the unemployment costs would be too high, too persistent. In Burns’ view, monetary policy wasn’t as effective as it could be, should be. Fiscal policy was important, all those cost-of-living things and union contracts, et cetera. He was afraid. He didn’t want to incur the cost of fighting inflation. Volcker said, “We’re going to incur it. It’s going to be a one-time cost, but it’s going to change everything.” It did. We had basically, what, 20 years, 30 years of expansion after inflation expectations came down.

I think another important point about Volcker, and this will get us into Greenspan a little bit, was he didn’t keep pushing it until inflation hit a very low number. He backed off in the second half of 1982. There were a couple reasons for that. The reason given was that we were targeting money. Maybe this is something we can get into later because Kevin Warsh talks about targeting money or talks about money supply as an information variable. Deregulation meant that the relationship of money to income and to prices was breaking down. That was the reason we gave.

I think the real reason was inflation expectations were coming down. The fever had broken. Financial stability was at risk. There were several very large banks, particularly ones that had made loans in Latin America. Walter Wriston will never lose money on these loans. He had the good sense of saying, “Okay, we’ll back off now, but we’ll keep our vision intact. We will always be aiming.” Certainly, every speech he gave emphasized price stability and monetary policy, even though it backed off when inflation was 4%, 5%, in ’82. He kept pushing in that direction.

I think that’s also Alan Greenspan. Greenspan greatly admired what Volcker had done. He thought it was a terrific thing, and the country set the economy on the right path. He was going to finish the job. Now, he didn’t immediately come in and say, “Well, inflation’s 3% or 4%. Let’s get it down to 2% or 1%.” He emphasized the price stability mandate. He resisted any tendency for inflation to rise. He kept a very careful view on inflation expectations, particularly as it was reflected in the bond market. That formula, along then with a productivity increase in the ’90s, we achieved price stability in the 1990s, but it wasn’t instantaneous. It was done with the economy expanding very, very nicely in those years.

Beckworth: Now, you were a governor from 2002 to 2010. You were also the vice chair. You were a very senior person at the Board of Governors. You were at the top. You were the trifecta. You were leading the charge, leading the Fed. 

Kohn: Ben was leading the Fed.

Beckworth: You were his top lieutenant.

Kohn: I was his lieutenant.

Working with Alan Greenspan

Beckworth: There you go. You bring to the table all this institutional knowledge on top of being a senior official. You mentioned when Alan Greenspan joined that he turned to you. He relied heavily on you and that he even said you were his tutor of sorts, right?

Kohn: Mentor. He kept calling me his mentor.

Beckworth: Wow. Tell us about that.

Kohn: I think he was being nice. To a certain extent, when he arrived in 1987, he needed instructions on how the Fed worked, how to interact with the staff, what to do. I did do some mentoring of that sort, the arcane ways that the Fed works. We worked very closely together, particularly until 2002 when I joined the board, particularly 2000 when I left Monetary Affairs. We were partners to some extent, but he was the senior partner. There’s no question about that.

Beckworth: Sure. You were the person who brought the institutional knowledge, how to connect. I understand that back then that was important to have the right relationships with the staffers. You can’t just run over them. You’ve got to work with them.

Kohn: Greenspan loved that. I would say after he’d been at the Fed for a couple months, I thought, “This is a guy who’s like a kid in a candy store.” He has a question about housing, has a question about the equity markets, he has a question about labor markets. There’s some staff member that he can contact and work with that person. He was a very intense user of the staff. He would find the expert, even though the expert was two or three levels down. He would tell the division director what he was doing most of the time, but he worked very intensively with the staff, and he loved it.

Beckworth: Oh, that’s great. Now, during that time, were you the division director of Monetary Affairs?

Kohn: When he came, there was an opening in the R&S, the research and statistics division. The main domestic research division [director] had left. That was an opening. There was a competition, or it was uncertain who would succeed him. I was one candidate. Mike Prell was another. Greenspan said to Volcker, “I don’t want to lose these people. Work this out. Figure this out. I don’t know these people. You figure it out.”

Volcker left the board. He wasn’t there, but he occasionally showed up in an office down the hall. He worked with various schemes. Eventually, what they did was they gave research appropriately—this was a good choice—to Mike Prell, research and statistics, producing the forecast for the FOMC, overseeing a lot of domestic research. But they broke off some of the financial pieces of the research division, created a division called Monetary Affairs for me.

Beckworth: Oh, wow. Really?

Kohn: That division still exists.

Beckworth: You are the original director—

Kohn: —of Monetary Affairs.

Beckworth: Wow. Did not know that. You were avant-garde, a trendsetter at the Board of Governors. You led out there. I’ve been to conferences before where you were on a panel, and you have some of your former subordinates, colleagues. I’ve heard them say many times that you were this great mentor to many, many monetary economists at the Fed. You probably, when you look out and you go to conferences, it’s like, “Oh, I trained him. He was under me. She was under me.” You probably have a great legacy behind you.

Kohn: That’s one of the things I’m proudest of, really, how many people flourished as I was the head of the division, how many people still keep in touch. A couple of them who teach classes at Yale, MIT, Georgetown, invite me to come in and give a class every year.

Beckworth: That’s nice.

Kohn: It’s very satisfying.

Beckworth: Yes. Wow. What a rich experience. We’ve already touched on some of what you did with Alan Greenspan, but what would you consider the biggest moments during his time? He recently passed away. We’ve thought a lot about him. What would you consider the highlights of his tenure?

Kohn: For me, I think the first highlight would have been the 1987 stock market crash. The stock market went down, what, David, 22% in one day? It was more than 20%. I’ve talked to people who were in the market during that day, and they say it was total chaos. No one knew who was going to get paid, who wasn’t, et cetera. Greenspan was scheduled to give a speech, I think at American Bankers Association or something in Dallas. The decision was he should go ahead because if he didn’t, then things would look even worse. They got worse.

I think his reaction was really instructive. He said, “The Fed issued a statement saying, your nation’s central bank is going to supply all the necessary liquidity in this emergency situation.” Reassuring people and then doing it. Making sure the discount window was open, making sure open market operations was aware of any demands for reserves and for liquidity, and met those things.

I think he was calm. He understood the markets. He supported Jerry Corrigan, who was the president of the Federal Reserve Bank in New York, who was leaning all over people in both Chicago and New York to keep the credit flowing, keep the funds flowing. The natural inclination, if you’re Goldman Sachs or whomever, is to hold onto your liquidity. Jerry convinced all those folks that the nation’s interest, the financial interest of the country, was dependent on them continuing to send their payments forward, paying for what they had, receiving, keeping that stuff flowing. Alan Greenspan was very supportive of Jerry, who was, I think, pretty forceful in his discussions with these private sector people. That was one important thing. 

I think the second episode—it’s more than an episode, a period, in my mind—he was called the maestro for productivity call in mid to late ’95, ’96. ’95 resisting calls to ’96 to raise interest rates because they own them. I look at the few years before that, and they were very difficult monetary policy years. There was a mild recession in ’90, ’91, I think. Coming out of that recession, the fed funds rate had been lowered to the very low rate of 3% at the time. We kept it there for a while. There was huge pressure on him to continue to ease. That was really the first jobless recovery. He had his eye on inflation. This is pulling forward the Volcker story. He said, “No, we’re going to keep inflation headed in the downward direction. I’m not going to ease.” He was getting pressure from the administration, George H. W. Bush, publicly, not with the vehemence that Donald Trump has used, but publicly asked for interest rates to be lower.

After he left office, George Bush, in his interview with David Frost, retrospective, said of Alan Greenspan, “I reappointed him. He disappointed me.” Democrat, this was bipartisan. I remember sitting behind Greenspan at hearings, and Riegle, Sarbanes, and Sasser, three Democratic senators taking turns yelling at him about lowering interest rates, but he resisted. I think that was really helpful in cementing and keeping that downward pressure on inflation.

Then in ’94, he turned it around. He saw the inflation pressures rising. He started to raise rates. He raised rates quite a bit in ’94. I don’t remember the exact number, but it was quite a bit. He engineered a soft landing, and then he backed off in early ’95. This was like a classic soft landing of raising rates. We’ve had another example of a soft landing here, but inflation never got all the way back to where it should be, but certainly came way down under Jay Powell from ’23, ’24, ’25 without a recession. That was a classic. That took really a subtle grasp of what was happening in the economy.

I used to kid him that he would take one questionable number, divide it by another questionable number, and somehow come out with an indicator that told him exactly what was going on sometimes, or most of the time, not always. I remember some speech about Class 8 trucks in early ’95. I don’t remember. He loved economic research. He loved data. He knew the data very, very closely from his years as a consultant. He really looked very deeply. He could see when the economy wasn’t doing what people thought it was doing, and then adjust policy.

I think that period of resisting the declines and raising the rates, and then softening a little bit at ’95 to engineer that soft landing was a really important period. Then there was the productivity thing. He had that call. The standard conventional economists were urging him to raise rates because the unemployment rate is too low, inflation was going to rise, we’re going to lose some of these gains. He said, “No, no, no, something else is going on.”

There again, it was partly data-driven, so he could see that although the unemployment rate was low, prices weren’t accelerating, and labor costs were quite muted. If you look at unit labor costs through that period, because productivity was picking up, and profits were picking up faster than wages, and so unit labor costs were quite muted. There was a disinflationary effect of the surge in productivity’s temporary one. Importantly, by the end of the ’90s, in 1999, the push from not only investment, but particularly from consumption driven by the rise in the stock market, the dot-com boom, created an inflationary risk, and he started raising rates again.

Beckworth: It’s interesting to hear this story because he had a mental map. He had some capacity in his head to really navigate and see where things were going. We know monetary policy typically operates with lags, right? If you do something today, maybe six months, a year, but he was able to somehow still navigate, work with the committee, and it’s not just him, and yet when we step back and we look at that period, he effectively was following a Taylor rule. Even though he may not have explicitly been doing it, somehow he internalized the spirit of the Taylor rule in his actions.

Kohn: That’s right. He was reacting, to some extent, to incoming inflation and unemployment data, but he was looking ahead, but he was very skeptical about long-term projections. I think his vision was the next business cycle. Where are we in the business cycle, the next six months or a year? What’s happening to inventories?

We didn’t have an SEP at that time, but we did have projections in the semiannual monetary policy report called the Humphrey-Hawkins Report at the time. He didn’t submit projections because he said, “I don’t know what’s going to happen in two or three years.”

Beckworth: Well, that’s interesting.

Kohn: Every once in a while, Mike Prell and I would go to him and say, “If there’s a central—not a median but a central tendency, which they still do as the—this whole thing would make a lot more sense if we could take the staff projection and put it in there. That would make the central tendency line up with the story we want to tell.” He’d say, “All right,” but that didn’t happen very often, but every once in a while.

The Kevin Warsh Fed

Beckworth: Well, that’s interesting because that’s one of Kevin Warsh’s big thing is he really wants to pull back from forward guidance, at least the SEP part of it, and he’s in good company, I guess, of sorts, unless it’s different.

Kohn: I think there is a difference. I hope that Kevin Warsh moves in the direction of Alan Greenspan in a sense. Greenspan used to give forward guidance to some extent about the next meeting. Sometimes it was buried because he didn’t like to surprise markets a lot. Sometimes it was buried in a speech that no one understood, right? He wasn’t the clearest writer and speaker. I guess I’m complicit in some of that. People didn’t always get the hint.

He did forecast a little bit. And two points. One is in 1999 or 2000, the committee started publishing the tilt in the directive, which was an indication of whether policy was more likely to tighten or ease in the near term. In 2003, I think, there was a thing where we’re more worried about inflation than employment, or we’re more worried about employment than inflation, which also gave a sense of which direction policy was going.

I think the really important point is that Greenspan always had a narrative about what was going on and an explanation in his monetary policy testimonies. What’s happening in the economy? Why is it happening in the economy? What are the risks? How does the committee think things are evolving and why? Although that wasn’t a set of dots, it was a sense of what the committee was paying attention to, so I think this narrative is very important. That’s really what we’re missing so far from Chairman Warsh. The narrative has implications for policy.

When I gave speeches, I always thought of myself as talking about the right-hand side of a Taylor rule. What do I expect for output or employment and inflation? How do I see that evolving? Let people infer where I think interest rates are going, but they’re inferring. I think we need at least a narrative. We need to know why the economy is evolving or how the FOMC thinks the economy is evolving, why it’s evolving. This narrative has to be verifiable or falsified by incoming data or new analysis, and it’s a part of accountability.

If you think about Jay Powell and accountability, he’s been held accountable for transitory. He jokes about it himself. That’s the thing where he said, “Here’s my analysis or the committee’s analysis,” which he agreed with, “of what inflation was doing in 2021.” Monetary policy didn’t need to counter it for the following reasons, which turned out to be wrong. He had an analysis. He had a narrative. I think that’s really important. If I can continue talking for a second—

Beckworth: Yes. Please do.

Kohn: —I’m encouraged in the communications task force that Chairman Warsh has set up. We have, among other people, Mervyn King. Mervyn took huge steps at the Bank of England to clarify the monetary policy, newly formed Monetary Policy Committee in 1997, its thinking. There was always a section in their inflation report on the major judgments we need to make, the risks. It was a very full spelling out of what was going on in the UK economy and how they saw the risks and what judgments they arrived at to get that forecast.

Remember, Mervyn also had fan charts. Recently, people have said they’re not really fit for purpose. They’re not really telling us much. The idea was about uncertainty. Mervyn was very focused on uncertainty. Remember, he wrote a book with John Kay called Radical Uncertainty, great, very focused on uncertainty, very focused on the narrative. I hope that, and I know that Kevin Warsh has said, has many, many times talked about making policy in an uncertain world and the difficulties of doing that.

Having Mervyn on that communications task force, I hope, pushes Kevin and the committee in the direction of making a forecast, even if they do or don’t have dots, but making a forecast, and then explaining the forecast, so creating the narrative. I think that’ll satisfy. People said, “Well, don’t give us your forward guidance, but what’s your reaction function?” Well, you’re never going to get a Taylor rule reaction function, and you shouldn’t, but you should get a sense of their reaction function by what are they worried about, how do they expect things. I think that will go a long way to putting the communications in the right way.

Beckworth: That is so interesting. I should also mention to listeners that you also served as an external member of the Financial Policy Committee. You know Mervyn as well. You know so many distinguished heads of central banks over the years, so add that to your list. Going back to this question about Kevin Warsh and how much forward guidance does he give, what I think I’m hearing you say is make some kind of compromise. You don’t have to go all the way where you’re doing two years out. Have at least, like Greenspan, one, two meetings out of where you think you’re going, some kind of compromise. Or more than that?

Kohn: Actually, I don’t think he needs to do that, but I do think he needs to give us the information that we can infer that. Kevin’s worried about two adverse consequences of a lot of Fed communication. More than two, but let me highlight two right now. One is that Fed communication damps down the ability of the markets to interpret incoming data. Then the other is that, even if the forward guidance is not a commitment, it might make the committee a little more reluctant to change, make it harder to change the narrative, and therefore change the policy.

Now, I don’t know whether that’s true or not, but those are two concerns. I can see him backing off. In fact, I think there’s been some studies. Bill Nelson, you’ve had on here, he said at my recommendation, that said the market forward guidance didn’t damp market reactions to incoming data, at least back in the 20-teens or 2010, 2011, 2012 period. These are empirical questions, really.

I think he doesn’t need to give that, what are we going to do the next two meetings, meeting or two. And it’s part of accountability. You’re an unelected bureaucrat, and markets are going to react. When markets react to new information, embedded in that reaction is their expectation of how the Fed is looking at it. If you don’t tell them anything, they could react completely incorrectly, or in a way that it’s not really constructive to achieving your goals. The more information they have about how you’re looking at the world and how this information might affect that, I think helps them respond to incoming data but in a way that reinforces and helps the Fed to accomplish its own objectives, so they understand what the Fed is talking about.

Beckworth: Hopefully, Kevin Warsh is listening to this podcast, and he’ll take your counsel to heart. If nothing else, we have these tasks force. Like you said, Mervyn King will do great things with it. We’ll come back to those in a minute. We’re going to talk about the Fed’s Balance Sheet Task Force. I’ve thought a lot about that. 

Fighting Inflation

Before we do that, I want to just spend a little bit of time on the inflation issue. You mentioned Volcker fought the good fight, Greenspan continued it, had a great run. Now, we’ve almost had, not quite, but we’re getting close to six years of inflation being above the Fed’s target. Some of that, the first few years, okay, we had a pandemic, things happened. We’ve had a lot of struggle. I’ll just mention here, in passing, you and Gauti Eggertsson had a great paper, “The Inflation Surge of the 2020s: The Role of Monetary Policy,” highly recommend that paper to those who are curious the role the Fed played during the pandemic inflation. What do you think now? You mentioned this earlier, we had a soft landing, but we didn’t go all the way. We couldn’t land the plane completely. Why do you think that’s the case?

Kohn: I think a major contributor to the above-target inflation in the last couple of years. I think the Fed made mistakes in ’21 and in ’22 before it really got going. To Jay Powell and the Fed’s credit, he basically admitted, “We blew it, and we’re going to correct it.” Not many government agencies do that. He corrected it in a way that required unprecedented tightening of monetary policy over the second half of ’22 and early ’23. It was very courageous, and it worked for the most part.

We’ll get to why that might not have worked entirely, but it certainly worked to bring inflation way down but keep the economy going. Gauti and I emphasized the mistakes they were making in their framework of 2020 and the forward guidance they gave for interest rates and QE in that period. Again, to Jay Powell’s credit, they actually backed off the 2020 framework in 2025.

Beckworth: That’s a whole other discussion, but yes, that’s interesting.

Kohn: Right. More recently, I think we do know that tariffs, Iran, oil prices, supply shocks have contributed a lot to inflation. We don’t know how much. Where would we be today if Trump hadn’t done in what, in my view, are self-inflicted wounds here? It’s hard to tell. It was clear that Jay Powell thought that we’d be really close to 2% if the tariffs hadn’t intervened.

There are different estimates of how much the tariffs are worth, but they’re worth something for sure. Now we have the oil prices, fertilizer, all that spillover from that. Looking under that is really hard. I was concerned earlier in the year in particular that some of the service prices looked like they were firming up the service inflation. I often look at market-based core, because I think the imputations, particularly on financial services and some of the others that they put in there, I don’t understand them. They don’t make a lot of sense. They say they’re going to correct them in September to some extent anyhow.

There were signs of firming up, but I think we need to let these supply shocks abate a bit to find out. There is a risk. It’s amazing how well-anchored, particularly market expectations of inflation have been judging from the difference between nominal and real tips, real Treasury rates. The five by five, what do they expect for inflation five years out? Absolutely flat as a board for the last number of years, including through that horrible ’21, ’22.

Beckworth: That is a little bit puzzling to me, honestly, because I see things even beyond the supply shocks are trajectory for the fiscal deficits, and yet the bond market is pretty confident it’s not going to be an issue.

Kohn: Those bond rates have been going up, particularly last few months. Interestingly, and I did look at that just recently, a lot of the increase in long-term rates isn’t real rates. The inflation expectations, particularly near term, naturally, near-term inflation expectations, as measured in the bond market, say the five year, rose quite a bit as the oil prices rose. They came down with that memorandum of understanding because people thought, “Well, they’ll figure out some way of fixing this, however.” They came down. Even the five-year inflation expectations, which were elevated, are now back to a little over 2%, normal level. You’ve got the 10-year, the second five years have hardly moved at all. They’ve been a little over 2%.

Warsh talked about spillover into other prices. People talk about second-round effects. I think there are two things to keep an eye on there. One is wages and labor costs, and the second is expectations. I think, so far, the near-term expectations certainly are higher. I think it’s quite possible that they’re more sensitive following the 2021, 2022 episode. They’re a bit of a worry, but longer-term expectations haven’t. Labor costs, particularly, there’s already been a pickup in productivity, probably not AI-related, but a pickup in productivity. It looks like it’s 2% or a little over 2%, just from 2019 to 2026, so labor costs are well behaved. It’s worrisome. I think there are risks. I wasn’t comfortable with the December insurance thing, so I think I would want some confirmation that those supply shocks were feeding through and the effects of those were abating, and that underlying inflation was coming down.

One aspect of this course is the demand side from the AI buildout. Warsh, the other day, said, yes, prices are going up from the demand side, but also, he was trying to look at that all. He wanted to look through that as well. That made me a little nervous. Yes, so I think it’s certainly nervous-making. I think the risks are tilted to the upside relative to the 2% target. I would be keeping a careful eye, at this point.

Beckworth: One last thing on inflation before we go back to the task force. Again, I want to go to the balance sheet because you actually are part of the history, here, behind it. I want to tap into you, and, again, your long run at the Fed, your institutional knowledge. I shared with you an image, a chart. It’s from the Gallup polls. I actually learned about this from the late Robert Samuelson, who used to write for the Washington Post and, I think, Newsweek as well. He had a book that came out on the great inflation, and it came out in the worst time possible.

It came out in 2008, right when the economy is crashing. He jokes he’s terrible at marketing, but it was such an interesting read and a great conversation. It’s an early podcast. We’ll provide a link to that and a transcript for listeners. He pointed out that, in these Gallup polls, inflation was problem number 1 in the mid-to-late ’70s. You would think there were other things happening in the ’70s and, at times, it was higher than unemployment. Unemployment was high as well.

Then you get past the post-Volcker period, and then it’s always unemployment that’s big, and inflation is at a very low, low, low level. Then you get to the pandemic, and yes, inflation spikes again. What’s interesting is it hasn’t fully gone down. People are “once bitten, twice shy” about inflation. They’re a little more price-sensitive. I guess I worry that maybe inflation expectations are more susceptible to being moved if we don’t get things under control, but I want to get your sense of what to me was so interesting in the 2024 election. It seems like inflation was a big deal in the election. Looking back, is it similar to what you saw in the ’70s? Do people really hate inflation that much?

Kohn: Yes, and it’s clear. Personal anecdote: My Brookings colleagues in ’21 and ’22, I was saying to them, “People hate inflation. This is a bad thing.” It may not be Joe Biden’s fault or the Fed’s fault, a lot of it anyhow. Remember, the Bernanke-Blanchard paper said most of the early inflation was supply-side caused, and later inflation was demand-side, but it’s there, and people hate it. There have been studies and there’s a professor at Harvard, who has done surveys of people and confirmed that people hate inflation.

I think part of this phenomenon is, “When I get a wage increase, that’s because I’m a great worker. I’m being rewarded for my great stuff.” Price increases just erode that wage increase. Economists can look at the wage increase and say, “Well, that’s just keeping up with inflation. There’s not much of a real wage increase in there at all, maybe none.” But the worker says, “Well, it would be a real wage increase if these prices weren’t eroding my purchasing power.”

It’s something they deal with every day, and you can see that in the inflation expectations stuff. The short-term inflation expectations Michigan Survey, New York Fed, whatever, are very sensitive to gasoline prices, food prices, stuff that people shop for every day and that are essential, so people do not like inflation. You sent me that chart ahead of time. I thought it was really interesting because this “not worried about inflation,” that’s exactly Greenspan’s definition of price stability.

When households and businesses don’t have to pay attention and don’t pay attention to inflation, they just go about making their decisions about the labor market, about the product market, without worrying about, “Is inflation going up?” I agree with you that we’ve lost that to some extent. I think when the members of the Open Market Committee talk about risks on inflation, that’s an important piece. We’ve been over by so long. Yes, expectations, you can explain them with supply shocks and that kind of thing, so I think that would be part of the risk management side of this thing. Given the history, we need to be really careful that policy is in a position to bring down this inflation rate over time.

Balance Sheet Task Force

Beckworth: Don, let’s transition into the Balance Sheet Task Force that we talked about earlier. You mentioned Bill Nelson. Bill Nelson’s one of the people that you trained at the Fed. He’s been on this podcast a lot. Bill and I have talked a lot about operating systems, balance sheets, and such. We have now Kevin Warsh; one of his big hobbyhorses is the Fed’s balance sheet, and, by implication, the operating system. I’m delighted to have you here because you, arguably, are one of the architects of interest on reserves.

Now, that’s not entirely true. Congress had to vote on it, and you had to have the whole committee. I’m holding in my hands here a testimony that you gave on June 22, 2004, to Congress, and it’s on interest on reserves. You are making the case that we need to get interest on reserves. Let me just read the conclusion here, and this is to the Senate Banking Committee. You say, “In conclusion, the Federal Reserve Board strongly supports, as its key priorities for regulatory relief, legislative proposals that would authorize the payment of interest on demand deposits and balances held by depository institutions at Reserve Banks, as well as increased flexibility of setting reserve requirements.”

Of course, this does eventually become law in 2006. There’s the Financial Services Regulatory Relief Act, so they do bring this about. It was supposed to take effect in 2011; it got pushed forward to 2008. We have interest on reserves now; it’s a part of the monetary policy landscape in the US. I don’t think it’s going anywhere. To be clear, even someone like me who wants a smaller balance sheet, it’s still an important tool. Most central banks have a depository facility and a lending facility, and they both have rates that provide guardrails; market rates go between them. No matter what your preference is, you want to keep both, because there’s been some calls to get rid of interest on reserves altogether. I just think that’s foolish.

Kohn: So do I, yes.

Beckworth: In fact, I think you could tell this story. Before 2008, we did have interest on reserves; it was just 0%, right?

Kohn: Right. Right.

Beckworth: We had what Bill Nelson would call an “asymmetric corridor system.” The top may go up and down, but the bottom was always stuck at zero, so why not make it symmetric? That’s the beauty of it.

Kohn: We were forcing banks to make interest-free loans to the federal government by—we had reserve requirements; they weren’t high, but they were there—holding deposits at the Federal Reserve that remunerate to zero. As a consequence, of course, they tried to minimize those deposits. One way of minimizing the deposits was minimizing the amount of demand deposits, which was the primary source of required reserves. There was a lot of inefficient, resource-wasting effort to hold down demand, to sweep accounts and things like that. My argument in that testimony, as I remember it anyhow, was basically an economic efficiency argument.

I don’t think I was thinking, at that time, about the zero lower bound, QE, and, how are we going to tighten policy when we have a very large balance sheet? It was more about economic efficiency, and this didn’t make any sense, and a better rate, and less onerous regulation.

Beckworth: It’s interesting to see that conversation. Then there’s a 2008 paper that was published, and I imagine you oversaw this or you were a part of this as well. This was a paper, “Interest on Reserves: A Preliminary Analysis of Basic Options.” In it, there are basically five options that were outlined. I don’t know if you remember this note that was given—

Kohn: No.

Beckworth: —to the Board to review, as you were transitioning into interest on reserves. How do we do it? There were a number of options given. Option one: It’s a mouthful, “Remunerate required and excess reserve balances.” Actually, I think the proper name would be a “tiered reserve proposal.” Option one was, we’re going to pay required reserves at the deposit facility rate, interest on reserves, and then excess would be less. It was a proposal for a tiered reserve. 

The second option, though, was a voluntary balance target, and that’s the one that’s received a lot of conversation. Darrell Duffie’s mentioned it, Bill Nelson’s mentioned it, and I mentioned it in a Substack article because everyone else was talking about it. That’s, of course, a version of a tiered reserve system where the banks determine how much they want to hold, so it’s more market-driven. 

Then option three: let’s do a corridor, but again, it’d be a corridor where you have interest on reserves, so you move bands up and down.

Kohn: This is what happened basically.

Beckworth: Yes. Option four: a floor system with high balances. Option five: a wide daily band. There were many options on the table when we brought this on board. Give me a sense of what everyone was thinking at the time. You’ve already shared some of it?

Kohn: To tell you the truth, David, at the time, the financial system was frozen. 

Beckworth: Bigger fish to fry? Okay.

Kohn: Right. People were thinking about lots of things. I don’t remember—and it could have happened; I haven’t looked at the transcripts of the FOMC—that we had an intense and fully developed discussion of these various options. At the time, it was about we’re buying a lot of securities, that’s driving interest rates down, the FOMC hadn’t yet endorsed or come through with a zero interest rate thing; how can we keep control over the federal funds rate with a large balance sheet? I don’t think we had a discussion of tiering and all this other stuff. I think it was, “We’ve got this.”

Beckworth: Practical.

Kohn: It was delayed for five years because of budget scoring, as I remember. This was a CBO-driven thing, a Bob thing. Accelerating it in this emergency seemed like the right thing to do and certainly gave us a tool that we really needed under the circumstances.

Beckworth: Yes. To be clear, even people like myself or Bill Nelson, who want to see some changes, and even Kevin Warsh said this: “This is not an argument that you should never have a floor or never use QE.” The Riksbank, to me, is this model—and I know Riksbank is a small, open economy; maybe not a fair comparison, but they do QE that their system falls into a floor system, but then they go back out of it. They try to return to scarce reserves, or, in many cases, countries are going to a demand-driven, more of a ceiling facility.

I want to go back, though, to this point you’re making about all the inefficiencies that were being used, all the effort that was being used to avoid this tax on banks, and I wonder if it answers a question I’ve had. I agree we can never go back to pre-2008 systems, if nothing else, because there was no interest on reserves. It was literally 0%; you’d have all these distorted behaviors. Could you make the argument that the low level of reserves pre-2008 was inordinately low because banks were trying to play this game?

In other words, had banks had interest on reserves within a scarce reserve system, they would have gotten something. They probably would have had more reserves. It’s not even a fair comparison to say, “If I want to go to a scarce reserve system—” Pre-2008, it’s just an anomalous feature or creature.

Kohn: Yes, I agree. 

Beckworth: All right, so I think that’s an important context for people having conversations today. We’ll never go back to that. I don’t know any other central banks that do that, like an asymmetric corridor where there are zeros. Everyone has interest on reserves.

Kohn: Right. Right.

Beckworth: What other thoughts do you have on the Balance Sheet Task Force, thinking about today?

Kohn: I think it’s really an interesting and great task force, isn’t it?

Beckworth: Yes.

Kohn: You’ve got Karen Dynan, who’s a terrific economist and thoughtful person. Then you have two people who have given speeches at the Jackson Hole conference with the opposite perspective on the balance sheet. Jeremy Stein, 10 years ago, 2016, I think, gave a paper with Robin Greenwood at the Jackson Hole conference advocating for a large balance sheet in order to supply liquidity to the banking system.

That supply, their argument, I think, was—and I looked a little bit at this in the last day or two, but I didn’t read the whole paper, just read the intro—there’s a premium now on people desiring liquid assets. That premium can be met, or that encourages banks to issue short-term debt because they gather the extra premium that other people were putting.

If the Fed issues a bunch of liquid assets to the banks, that will discourage maturity transformation; that will discourage banks from issuing commercial paper, things like that. Their view was that a large balance sheet—so this is pre-COVID, but it was after the crisis—will act as a stabilizer on the financial system by supplying this liquidity and reducing the incentive for private parties, for the banks, to supply liquidity to other private parties. Interestingly, the other person, Raghu Rajan, had exactly the opposite perspective on this. He gave a paper a couple of years ago, at Jackson Hole, which said that the Fed supplying this liquidity encourages banks to supply liquidity to the private sector—

Beckworth: Highly runnable liquidity.

Kohn: —and runnable liquidity. I don’t know who’s right, to be honest. My reaction to Raghu’s paper was a little bit—there were two things going on in this period. One was QE, but the other was zero interest rates. A lot of the supply of liquidity came, I think, because of the zero interest rates, the effects of that, and the expectation that they would remain very low for a very long time, right?

What did Silicon Valley Bank do? Yes, they issued runnable liabilities, uninsured demand deposits, to fund buying long-term mortgage-backed securities. Oh, my God, right? They were taking a lot of interest rate risk, and I think that, in my mind, the failure of the supervisors was not giving a warning to the banks about the interest rate risk. Interest rates won’t be zero forever. They’re going to rise. You don’t know how high they’re going to rise. We don’t know how high they’re going to rise. You need to be careful.

At the behest of our supervisors and the FDIC, I gave a speech like that in, I think, early 2010 right here, close to the building we’re in right now, at the FDIC headquarters, at a conference there. I said, “You guys need to be careful. We don’t know what’s going to happen to interest rates.” I was wrong; they were zero for a very long time, but you need to be careful, and I didn’t hear that. I think that was what was missing. I think Karen’s going to have to negotiate between these.

Beckworth: Between the two.

Kohn: I like the idea of the task forces. I like the idea of bringing outsiders in to comment. I, myself, Mervyn brought me into the Bank of England in 2000 to evaluate their monetary policy processes, and I wrote a report that was somewhat critical of what they were doing. Then, subsequently, they had Kevin. Mark Carney brought Kevin in to talk about transparency at the Bank of England and transcripts they had and what should they do with them. Ben Bernanke—the Bank of England. The Riksbank, the Reserve Bank of New Zealand, and the Reserve Bank of Australia have all brought in outsiders to look at what they’re doing.

I think that’s a good idea. Now, who the outsiders are is important. It’s important to have a variety of views on these task forces. It’s important that the task forces command respect. I think for the most part—and I’ll come to “the most part” part in a second—these task forces are very well constructed to come up with some very interesting ideas. Then it’ll be up to the chairman and the task forces to sell those ideas to the FOMC, so that’s great. 

The one task force that I have questions about is that Productivity Task Force. He’s put three people on there who are part of the AI industry and are true believers. Now, Chad Jones is a terrific economist. I’ve heard him give talks. He’s pretty cautious about this. He says it’s going to take a while for AI to have an effect on productivity, but I think it would have been helpful to include someone on that task force who was a little more skeptical about, “This is going to happen,” or when it was going to happen. There are three terrific people, very knowledgeable, but it feels like the finger was put on the scale on that one, but not on the other task force.

Beckworth: Yes, I’m glad, too, that the balance sheet one, which is the one I care about the most, that you do have these two views, because whatever comes out of it, if you’re going to convince the FOMC, you’ve got to convince the champions of ample reserves that there needs to be a change. 

Let me end on this note here as our time is winding down. Even within the FOMC, even among ample reserve champions, there does seem to be some movement to at least shifting the demand for reserves. Even if you still keep ample reserves so the spreads are such that the IOR is the main rate, you want to shift it. One of the things that you would do in shifting it is making more access to the discount window, counting collateral there toward liquidity coverage ratio, being more willing to use it, bringing back term auction facilities, just make it part of standard operating practice like other central banks do, move more toward “a demand-driven system.”

I think that’s a great idea, though I’ve gotten pushback, like, “Oh, David, you’re going to increase moral hazard. You’re going to do all these things.” Now, I think there’s tradeoffs. Maybe so, but there’s reasons to maybe want to shrink the Fed’s balance sheet, too. Where do you land on this conversation? Is it a useful direction to go to make it more accessible?

Kohn: I think there are two things you can do to reduce demand. One of them is what you just said: Make the discount window or discount window-type facilities, like our repo facilities and whatnot, more regularly available, and reduce the stigma on that. I’m in favor of that. I think the Fed was founded largely to create a discount window because it was going to limit financial crises.

Beckworth: Yes, have an elastic currency.

Kohn: 1907 wouldn’t happen again, right? And it didn’t work because of stigma. There are several sources of stigma. One is how you appear to other people in the market. People in the market say, “Gee, Kohn National Bank had to borrow; something’s wrong there,” but that’s partly because Kohn National Bank intersects with the Federal Reserve, and the Federal Reserve, for a while, discouraged that borrowing. I think the Fed, even before Miki Bowman got in there, there was already a movement to make the discount window more usable from the Fed’s perspective. 

The other source of stigma that people don’t talk about is the political thing. We got to the supervisors partly, I think, took their cue from our elected representatives. Remember, in 2008 and 2009, if you borrowed from the Fed, that was considered a bailout. The 2010 Dodd-Frank Act said if you borrow from the Fed—and I assume this applies to the repo window as well—the information has to be published in two years, so there’s these transparency things. I’ve had conversations, some of them roundtables organized by Bill Nelson, where the people who were the treasurers, the funds’ managers of the banks, and they were asked, “Why don’t you use the window?” And a lot of it is, “My boss tells me that if he’s called before Congress and has to testify, I’m fired,” or, “If he gets a call from the Fed, I’m fired.” The Fed can take care of that. 

The political part, I think, is harder. Somehow we have to convince the politicians that the discount window is okay; it’s not a bailout. It’s at least a slight penalty, and we’re not keeping alive organizations that otherwise should be failing. People don’t talk about that, but maybe since I testified—

Beckworth: I’m glad you’re talking about it, yes.

Kohn: —in 2009 and 2010, where I was beat up by Senate and House committees about the Fed lending, I’m very sensitive to that. The other thing that can be done to reduce demand is not only make those facilities more usable from the Fed’s perspective—and the Fed’s moving in that direction; that’s great—but also look at your liquidity regulations, your liquidity stress tests, and what people can assume when they’re doing that, the resolution plans, what they’re allowed to assume. I think part of the problem, part of the demand for reserves, came from the supervisors, the FDIC and the Fed, insisting that, at least, particularly for the resolution recovery plans, you have instantaneous central bank money available to meet some of these needs, so reserves at the Fed.

I think there are things that can be done. I worry that we don’t back off so far that we make the system more vulnerable systemically. You mentioned I was on the Financial Policy Committee at the Bank of England. We were looking at systemic risk to the UK financial system, and maybe these are the scars I bear from being the vice chair under Ben’s leadership in 2007 through 2009, 2010. I really think we need to have a banking system that’s resilient, a system that’s resilient to most shocks.

There’s a tail risk, a 1% or 2% tail risk that you can never cover. This is part of what Congress is complaining about: The banks need to supply their own liquidity; the government shouldn’t be doing it, et cetera. Yes.

Beckworth: Yes, that is a great observation about the political challenge of going to fewer reserves, lowering the demand for reserves. Here’s my pitch, Don, and I mentioned it earlier. That is, yes, banks might be using the Fed more, but again, doesn’t it bother you that the Fed has such a big footprint in financial markets now? If you’re worried about political appearances, you’ve got that. You don’t have interbank lending. Look, if you want more markets, then you need to give up something over here. You need to allow the banks to engage more with the discount window.

Kohn: I don’t find the footprint argument all that persuasive. It’s true that the interbank market doesn’t function now, but there are lots of ways that banks adjust liquidity. I think if you went out and asked a bank, “Do you have trouble adjusting your liquidity?” They’d say, “No, we have 80 different ways on the asset and liability side that we can adjust our liquidity.” If you ask the Fed, “Are you having trouble getting signals about where the pressures are in money markets?” “No. We look at repo markets, September 2019.” The disappearance of the fed funds market to me is not—

Beckworth: A nothing burger? Yes.

Kohn: —a huge deal. The Fed has a bigger footprint; they have more securities, and presumably, to the extent they’re longer-term securities, they’re suppressing the term premium a little bit. I think as the volume of federal securities, debt securities explodes, the proportion held by the Fed is getting smaller and smaller and smaller, so I think their effect on market prices, which were substantial when they bought the securities in huge size, is diminishing.

I don’t buy the footprint argument particularly, but I think that this discussion is sparking a discussion of, “Do we have our liquidity regulations set up right?” It’s sparking a discussion, “How can we make the discount window and related facilities more usable?” That’s a great discussion to have. The other part that I hope this terrific task force looks at is not only the level of the balance sheet and how to get it down and these things we were just talking about, but the composition.

What should be the maturity distribution? Does it matter? In some sense, the Treasury can adjust to whatever the Fed does, but I think it’s worth thinking about. Then the change. One of my disappointments at the five-year strategic review which was advertised as a review of strategy, tools, and communication; they certainly did strategy, and they moved back from 2020. They did communication and didn’t come up with any innovations, but they apparently had quite a discussion on communication; they never really talked about tools.

I wrote a blog at Brookings saying, “You guys ought to be talking about tools. What are the lessons learned from the forward guidance and the QE that you did?” It was not totally well received inside the institution, but I still think a lot of people have said, “It’d be better if you spelled out the difference between a market stabilization, market-functioning QE versus a monetary policy QE. Think about the criteria you’ll be using.” You can’t be real specific for each of those. Think about how little you can do and achieve. So I hope that task force also looks at when to trigger QE, for what reason, and how to determine what’s the best way to go with the QE.

Beckworth: That would be fantastic. On that note, our time is up. Our guest today has been Don Kohn. Don, thank you for coming back on the program. 

Kohn: It’s been a good discussion, David. Thank you for having me on.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show @Macro_Musings.