Narayana Kocherlakota on the FOMC, the 2008 Crisis, and Monetary Rules

Narayana Kocherlakota is the Lionel W. McKenzie Professor of Economics at the University of Rochester. He has published widely in economics, including in the areas of money and the payment system, business cycles, financial economics, public finance, monetary policy, and dynamic games and contracts. Formerly, Narayana was the president of the Minneapolis Federal Reserve Bank, where he served between 2009 and 2015. Narayana joins David on the podcast to discuss to discuss what it is like working as a Fed president and a member of the Federal Open Market Committee. He also shares some of his thoughts on the drawbacks of current proposals on establishing monetary rules.

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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: Narayana, welcome to the show.

Narayana Kocherlakota: David, thanks a lot, it's a pleasure to be with you today.

Beckworth: It's a real treat to have you on board.

Beckworth: I want to begin by asking, how did you get into macroeconomics?

Kocherlakota: Well, that's a great question.

Kocherlakota: I liked macro, really from the very first course I took in it, which was, with Alan Blinder, when I was an undergraduate of Princeton. And I majored in math at Princeton, but I really quickly realized that I was missing that connection to the real world, to real world problems that economics provides, and so, when I applied to graduate school, it was in economics, and not in math.

Kocherlakota: And I always thought of myself as being interested in macro, and being interested in macro questions, and right from my freshman year of college, and then on into my first year of graduate school, I found macro fascinating.

Beckworth: So we can thank Alan Blinder for your success as a macroeconomist, at least, getting you going?

Kocherlakota: Al was an inspirational instructor. That's for sure, yeah.

Beckworth: Okay. All right.

Beckworth: Well, I want to move onto the area that many of our listeners will be eager to hear, and that is your experience as a regional Fed president at the Minneapolis Fed. And I'm going to work through some basic questions with you.

Experience as a Regional Fed President

Beckworth: I want to begin by asking, what was it like to be one? What did you do first thing in the morning? Did you get up? Did you read the newspaper? Go online? Did you get briefings from your staff?

Kocherlakota: No. Most days I was checking, I would guess, market signals. So, I'd be looking at what was going on in... I tend to focus more on bond markets than maybe on equity markets, so I'd be looking at was going on in bond markets, maybe foreign exchange. Depending on...

Kocherlakota: Some of this timeframe, I was president from 2009 to 2015, so the real market instability had calmed down to a considerable extent, but we had periods where there was a lot going on, just to put it mildly, and keeping up with markets, I view that as being pretty important. I'd read the major newspapers, The Times, The Wall Street Journal, the Financial Times.

Kocherlakota: And increasingly, as I moved along in my job, I appreciated, I would say, reading through a number of blogs, I read, fairly regularly. And I thought those were quite useful, in terms of keeping up with what was... Keeping up with how others were viewing the Fed. I think that one of the challenges, when you're inside the organization, is you're all talking to each other, and it's hard to have the appreciation of how outsiders view us. And the blog site, I found to pretty helpful along that dimension.

Kocherlakota: Financial market participants are also useful to... Are also useful, but I ended up not really following those publications, I would say, at all. I relied more on reading in the media, and in blogs.

Beckworth: So, was there ever moments, when you're reading a blog, you want to pull your hair out, and say, no, no, no, you got it wrong. But you couldn't because you're the Fed president?

Kocherlakota: Yeah, of course, that happens.

Kocherlakota: I think it's more that, boy, you're reading some people who are trying to follow Fed extremely closely, and it's more common than our own communication, that, boy, we're not communicating effectively... Here's an individual who doesn't understand what we're trying to do, and they're very smart, and they are trying to understand what we're trying to do.

Kocherlakota: So, I thought it useful as a way to think on my own communication, as an individual member of the committee, but then also, how was the committee doing, in terms of overall communication.

Beckworth: I remember, probably during that time, maybe 2010, 2011, Tim Duy, from the University of Oregon, and still does, writes on the Fed, he's the Fed watcher. And James Bullard, the president of the St Louis Fed, he wrote a piece where he actually responded to what Tim had said, as president.

Beckworth: So, I found that very fascinating that someone like him was following, and you've just confirmed that, you two were looking at what people were saying, and commenting on the Fed.

Kocherlakota: Yeah. I think the key to that is, you don't want to get into back and forths about picayune details of economic theory. But I do think it's...

Kocherlakota: Someone like Tim in particular, he's obviously a very thoughtful tracker, what's going on in the Fed. And he doesn't seem to have an obvious advocacy role. So, then that's a person you're hoping really does understand what... I, as a member of the committee is trying to communicate, and also, what the overall committee is trying to communicate.

Kocherlakota: So, he's a good example of someone that... If he's not understanding what the committee's saying, then the committee's got a real problem.

Beckworth: That's interesting. Using people like Tim as a measure of how well you are communicating. So, that's neat to think about that.

Beckworth: Let's talk about your job as president. Your title is president and CEO, so I'm wondering how much time did you spend on administrative issues, versus thinking and preparing, over monetary policy?

Kocherlakota: So, I saw the job, as it unfolded, as having three different components.

Kocherlakota: So, one was the monetary policy side. The second, which was closely related to that, although, distinct in some ways, was external communication. Which is really, a two way communication.

Kocherlakota: So, talking to people around my... The 9th District of the Federal Reserve in particular, about what was going on in their economies, and then you taking that information forward to the FOMC. And then, also, communicating then, again in the 9th District, about how is the Fed approaching policy, and how I, in particular, am thinking about policy.

Kocherlakota: So, the 9th District was huge. So, that external communication actually ended up taking a lot of time, and you have to be very careful what you say in those... In that kind of job. So, planning and thinking about how you're going to say what you're going to say, that takes a couple... A lot of time.

Kocherlakota: So, the 9th District, just for your listeners' sake, includes the states of Montana, North and South Dakota, Minnesota, and parts of Wisconsin and Michigan. Just to give you a feel how big that is, when I flew from Minneapolis to Helena, which is... We had a branch office of the Fed was located in Helena, Montana. So, I actually made that trip quite often. It took me as long as flying to Washington DC from Minneapolis. So, it's a big, big district. Not that many people live there, so, fewer than nine million people.

Kocherlakota: So, then the third component is, as you're suggesting, management. You are the CEO of an organization of a thousand people, or more, actually. And then you're really... The tougher part of the job, even than that, is you're trying to provide a collective leadership to all 12 banks at once.

Kocherlakota: And the reason I say that is that, when the system was first set up, back in 1913, each of the banks were really separate corporate entities, and they're still structured that way, legally. But by now, in 2016, a lot of what the banks do is really collective. So, something like information technology, for example, really, is shared responsibility of all the banks. And that entails a lot of collective management. And you end up spending a lot of time on those, I found, on those kinds of activities.

Kocherlakota: So, I think all told, if you thought about policy as being between 25-30% external communication, being around 30%, and then the remainder being management, I think, certainly by the end of my term, that would be a good description of how I'm spending my time.

Beckworth: Okay. And when it comes to speeches, all the presidents give speeches. I'm wondering what motivates one to do a speech. Do you see an issue you want to speak to? Or do you have an expectation that you'll do a certain number of speeches each year? How did you come about doing your speeches?

Kocherlakota: So, by and large, you don't speak unless you're invited.

Kocherlakota: And this is something that is not well understood, I think, even by a relatively sophisticated Fed watchers, because I actually think... I understand the confusion, because they think the Fed is planful about its communication. That actually is not true. Or at least, that was not my experience. My experience is, you could be invited to give talks, and a lot of them... I was...

Kocherlakota: Anything that came within the district, I would be taking very seriously, immediately. So, anything in those, that six state region, that immediately got, in my case, I immediately start to put that very high up on the list of things you might consider.

Kocherlakota: So, in the year, my first year as president, and then again, in the centenary year of the Fed, I think I hit all six states in the district. So, that kind of regional interaction was really what I put a lot of weight on in my time.

Kocherlakota: Now, so you're going to accept an invitation, and the invitation might come six months, or nine months, before you actually give the talk. So, you have no way of knowing what you're going to talk about at that time. You just know that something is going to likely be on the table, that is worth communicating.

Kocherlakota: And when you get there, to that point in time, and generally it's three weeks or four weeks before the actual talk, you'll start to plan what's going to be in there. I would say, in general, you're looking to give, where the economy is, where it's going to be going, going forward, and what all that means for monetary policy. That would be a very standard talk. Sometimes you would give something a little more... If I talk to the university, I might give something a little more richer on the economics front, and how economists think about things, that kind of thing.

Kocherlakota: But the general talk to a typical audience would be, where is the economy now, where do we expect it go, and what does all that imply for policy.

Beckworth: And when you wrote your speech, did you vet it with your lawyers, and your staff economists, before you went out to deliver it?

Kocherlakota: I had a team of folks that looked at it before I... A combination of people in external communications, and also in... Basically, PhD economists. I might reach out to a broader set of people in terms... Like, I was talking on supervision regulation, I would turn to those folks for support as well.

Kocherlakota: But, no, there was no standard need to talk to a legal team, no. That was not part of the protocol.

Beckworth: Okay. So, let's talk about the FOMC, the big meetings that everyone pays attention to, and cares about the most, probably, as an outside observer.

Beckworth: How did you prepare for that? Did you have staffs come in with briefing material, and give their views? And I'm also curious, in that discussion, was there disagreements among the preparers? And you had to make a stand, this is where we're going to go, as a bank?

Kocherlakota: Well, it's a relatively large group of people who are involved in the briefing process. But let me start, in terms, logistically.

Kocherlakota: Generally, we would start preparing... I think the week before the meeting was a pretty intensive one for staff, and for myself. And generally, they would be approaching the meeting as separately from me to begin with, and we would all come together on Friday before the meeting, to really try to see where things lay.

Kocherlakota: Yeah, there was a lot of... A lot of people would have different views, and you'd hear a lot of different perspectives from a lot of different folks, at different points in time. It was a very complex environment we're dealing with, and it's pretty natural that you have smart people in a room, you're going to get a lot of different perspectives.

Kocherlakota: At the end of the day, it was my... I had to make the call about what we say at the meeting, and what perspectives get offered in that setting. But, hearing the different views, I think it's certainly incredibly helpful in terms of forming what I'm going to be saying at the meeting, obviously.

Beckworth: Yeah, I've talked to David Andolfatto several times, and he's been on the podcast as well, and I know, sometimes, I've reached out to him, and he's been real busy. Okay, Beckworth, I'll get back to you after the briefing. So, really, when it comes time, he's focused like a laser on it, and it consumes his every energy.

Beckworth: So, you fly to DC, do you bring staff with you? Do they come into the room when you guys do the FOMC meeting?

Kocherlakota: So, we have... Each Fed president, outside of New York, so non New York presidents are each bringing one staff person with them. And that's typically the research director, but not exclusively so.

Beckworth: Now, once on Twitter, we were talking about Richard Fisher from the Dallas Fed. I think you pointed out that he had proposed something like a nominal GDP targeting rule, except he would focus on personal consumption expenditures, that city part of GDP. And we were all shocked, like Richard Fisher. It was flabbergasted. But then you pointed out that it was Evan Koenig, one of his staffers, that motivated him, and I've read his papers on that, I really like them.

Beckworth: But you suggested on Twitter, that shows the importance of a really good staff, or the influence that a staffer can have on a president. So, can you speak to that? Are there times where a staffer comes before a president, and really turns on the light for them, and shows them an idea they want to push?

Kocherlakota: Let me see... I think, it's almost like, in my own case, there's just so many different places where... You're talking continually to people about policy, so it's sort of hard to identify that.

Kocherlakota: I think that, the example I say with Richard, is one of the more striking, simply because, I thought it was interesting, as you highlighted, the extent to which nominal PCE targeting might not be seen as something that Richard would be talking about in the meeting.

Kocherlakota: In my own case, I'm talking... I come to the meetings with a different background than Richard, and so, I think more natural for me to be talking on a more continual basis to staff about how they were seeing issues. And it's just more of an ongoing influence, in my own case, than an aha moment that I could really point to.

Beckworth: Well, you're an academic, you know the literature well already, so Richard was a banker, am I correct? And he comes in, and he may rely more on his staff.

Kocherlakota: Richard was a guy who came in more as a market participant, I would say. That that was his background, and he also had... He had done a number of things, but I would say the relevant experience that he found helpful, when he talked about monetary policy, was, his experience as a market participant, typically.

Beckworth: Okay. So, now you're in the FOMC meeting, you've got your one staffer there with you. What was it like in the meeting? Can you walk us through a typical FOMC meeting during your experience there?

Kocherlakota: Yeah.

Kocherlakota: So, you're in a very impressive room, first of all. It's the boardroom for the Federal Reserve Board of Governors. And you're all sitting around at an enormous table, that is the... At full strength, 19 members of the committee, although, I can't remember how many times we actually had 19, it wasn't that many. And then there would also be staff at the table, in particular, the head of the New York desk, markets group, is typically there to help the committee with what's going on in markets. And now the staff, staff will be there as part of the meeting to present relevant materials to the committee. So, that's what you have in mind, an enormous table, you have 19 principals, as well as some members of staff as well, from both Washington, and New York.

Kocherlakota: I think one thing that... To say about the meeting, which was really critical, is that... The baseline case, for what the committee is going to be doing, and how the committee is going to be thinking about policy, is really framed more by input from staff in New York and Washington, than from the non New York banks.

Kocherlakota: I think, and this is actually something I only realized after I left the committee, but I think the right way to be thinking about the committee is, the non New York banks are really like external members, and then the inside members of the committee are the members of the Board of Governors, and the New York Fed.

Kocherlakota: And actually, when we sat around the table, that description is mirrored by how the ordering looks through the seats. So, the vice chair of the committee, who is typically, by custom, the president of the New York Fed, sits next to the chair of the committee. That's to her right. And then to her left, that will be the vice chair of the Board of Governors, who is Stan Fischer. And then all the governors are, I think in order of seniority, next to vice chair Fischer. And only then do we start to get into the non New York presidents, and we'll circle around to...

Kocherlakota: We all have fixed places where we sit, from meeting to meeting, we don't get to move around. I was... Minneapolis is a little quarter to itself, I would say. To my left, is always president Evans, president of Chicago Fed. And on my right, president Bullard, of the St Louis Fed.

Kocherlakota: Yeah, so I think, beyond the seating, I think it is important to think about the meetings as really being the Board of Governors, and then the New York Fed... Those staffs are really working together to formulate... To help the committee guide the formulation of what I always say, the base case for policy.

Kocherlakota: So, what happens at a meeting? What happens is, there is first a presentation. At a typical meeting, there are other elements that could be entering in about this, but staff will make a presentation about what's happened in markets over the past... Over the inter-meeting period. There'll be a presentation about the economy, how the economy is likely to evolve.

Kocherlakota: And then each member of the FOMC will speak in turn about how they see the economy. So, all the 19 participants, if they're all there, will speak in turn about... And those presentations, depending on the person, can last a fair amount of time. The chair then summarizes that... Everything that she's heard, and then will offer her own... Typically, will offer her own thoughts.

Kocherlakota: So, both chair... Chair Bernanke and Chair Yellen, tended to lead from the back, so to speak. So, they tended to come in at the end of the round, the first go round, to describe how they saw things.

Kocherlakota: So, that's the economy go round. And that's... There's an attempt to keep that round pretty free of policy consideration. So, that's an attempt to get a clean look at the economy and the outlook.

Kocherlakota: Then, well I have a presentation from staff, on the policy options. Those will all have been circulated well in advance of the meeting, typically. And there's a... If you go back over the transcripts, you'll see the option B, typically is the one that gets chosen as the chosen course of the committee.

Kocherlakota: And that's... The idea is that B is likely to be the one that's going to be picked by the committee, and then alternatives A and C are... A is typically more dumbish, so to speak, than what the committee will choose, and C would always be more hawkish.

Kocherlakota: And those are the staff... Staff will present a statement associated with those various alternatives, and people will... Then each participant will speak in turn about their views on policy, and, again, the chair will wrap things up on that.

Kocherlakota: And that policy go round, unlike in the economy go round, the vice chair of the committee usually goes last... Is a penultimate speaker. So, as the president of the New York Fed, will be the penultimate speaker in that go round.

Beckworth: Does that happen all on the first day? Or is that over two days?

Kocherlakota: Over a two day meeting, that will happen over two days.

Beckworth: Okay. So, how do they get the announcement out? What time... So, today, they're going to be meeting on Tuesday, Wednesday, or... On the second day, did you stop at some point, like mid morning, you give time for the secretary to run out, type up the message, then you guys, has to come back to you, and you have to approve it before it's released?

Kocherlakota: No, the statements will... And if you go back to the transcripts, you'll see this, just to be clear, I have to be adhering to what's already been released publicly on this stuff.

Kocherlakota: If you go back to the transcripts, you'll see that what happens is that, the way you get 19 people to actually agree on a statement, is, you circulate that, all this material ahead of time. And so, for an option A, there's a statement, that's detailed, that will have the usual hundreds of words in it. Those for option B, there'll be another statement that will also have hundreds of words, and option C will be the same. And the committee is by and large choosing among those three potential statements, they're free to... Up to them, it's not staff that chooses things, it's up to the committee to... Certainly have heated attempts at wordsmithing. If you go back to 2009, or 2010, you'll see lots of wordsmithing going on to try to change the statement.

Kocherlakota: And the reason for that is twofold. One is to try to shape what the public and markets are going to be thinking about what the Fed is likely to do, but it's also important to realize that the statement plays the role of a contract among the people in the committee. So that, they have a complete and understanding of what they've all agreed to, in terms of policy.

Kocherlakota: And so, and that's another reason why wordsmithing ends up playing a big role in the conversation.

Beckworth: Okay. So, you have plan A, plan B, plan C. Now, something I've heard about the FOMC is that members have become more guarded in what they say in their presentations because they know, five years later, transcripts will be released. Do you think this is the case?

Kocherlakota: I have no idea what it was like... It was always true when I was there, that everyone was aware that transcripts are going to be released. I can speak for myself that was not a material consideration for me at any time.

Kocherlakota: What was a material consideration is, there's people, and Janny Ellen's famous for the level of care that she brought to the table, in terms of her preparation. And that set the standard. And so, you don't want to be seen as just winging it on these important issues.

Kocherlakota: So, I've felt, coming in, that, boy, yeah there's a real need to prepare ahead of time, in terms of what I'm going to say, and how I'm going to think about things. You try to be responsive, and I certainly made every effort to do that, to what's being said in the meeting. But monetary policy is not something, usually, there are certainly exceptions in the timeframe I'm talking about, but usually, it doesn't matter if you... It's more something that can be discussed over time.

Kocherlakota: So, if I say something in a meeting, and Evans responds to it in the next meeting, well, that frequency of interaction is good enough, so to speak. It's not like we have to settle it right then in the meeting, who was right on an issue. It's just that the pace... That's the pace of monetary policy. You're really setting an instrument that's going to have its impact on the economy 18-24 months down the road, so we have a little bit of time, usually, to get things right.

Kocherlakota: So, yeah, I've been told the same thing. I have no feel to what extent that's true or not, that keeping track of the transcripts to change things. For me, as I say, was having role models like Janet Yellen, she was clearly very well... As soon as I came to the committee, she saw that she's somebody everyone listens to extremely carefully, and she's also somebody who comes in extremely well prepared. And so, okay, you know what you have to do then.

Beckworth: So, I guess the question I have then is, you want to avoid groupthink, you want to avoid looking controversial, maybe. Like you say, coming prepared, look professional. But you don't want to do that to the extent that you're holding back what you really feel, and what you want to say.

Beckworth: And now in your case, we used to joke on Twitter and stuff, that we could identify your dot plot. Because you tended to be, near the end of your stay there, you were more the dove, we missed you once you left, because that outlier dot plot was missing.

Beckworth: So, I get the sense, you definitely voted your mind, but I guess the concern I would have is, to what extent is there holding back, and maybe not the fullest exchange of ideas, and engagement. But what you said earlier, was that there was a lot of give and take.

Kocherlakota: I did not think that there was any holding back that I sensed.

Kocherlakota: I think... But, it's not... It's a group that is trying retrieve good answers to tough questions. And that doesn't necessarily mean that you say the first thing off the top of your head when you hear someone say something you disagree with.

Kocherlakota: So, if you go back to the transcripts for 2010, you'll see great examples of this, where I made a case that a lot of the unemployment that we saw in the US was structural, and so, very difficult to treat using monetary policy. You will see, in the next meeting, not necessarily in that moment, not in that meeting, but at the next meeting, you'll see that other members of the committee, and then president Yellen of the San Francisco Fed would be an example, but others as well, had gone back to their staffs, talked about what I said, and then come back with well formulated critiques of what I had said.

Kocherlakota: And I think that's a great... What would you want from a committee, except that... I think it ends up being... It's definitely true that people said what they wanted, and there was a lot of disagreement. That doesn't mean you have to be calling... Try to call each other out on the fly. It can be... It's actually more useful, more productive, to have people go back and go to their staff about... To try to give as full and rich a response as possible.

The Fed as a ‘Small-C’ Conservative Institution

Beckworth: All right, well let me segue way into this, and that's current Fed policy, but it also speaks to what happened there, and maybe you can speak to this question I'm going to ask. And that is, what if you did come into the meeting with a very different view than everyone else?

Beckworth: So, I know we've talked on Twitter about this, and you know my views. I think the Fed has been too tight, for most of the period since the crisis started. I think they were behind... They fell asleep at the wheel in 2008. I had Andy Levin on the show recently, and he thought the same thing. In fact, Andy Levin's very critical, he thinks the Fed, they need more diversity on the board, more diversity of the Feds. Just, and he argues, man, if the Fed just talked to somebody to someone in the marketplace, in the street, they would have known things were worse than they had perceived in 2008. And he thinks it's easy to get lulled into groupthink there.

Beckworth: So, is it easy for someone who has a radical idea? Someone who says, hey, let's overshoot the inflation target. Let's allow inflation to drift over the target. Is there space in that discussion for someone like that?

Kocherlakota: It's definitely an institution where... Which is small-c conservative. And what I mean by that is, that it takes time for new ideas to make their way from consideration to adoption in the Fed. And that's the truth of the matter.

Kocherlakota: With that said, I think that Charlie Evans started talking publicly about the idea of thresholds in 2011. I want to say, the second half of the year. And we ended up adopting thresholds as a policy tool at the end of 2012. Maybe that conversation should have happened earlier, during the recovery. But I don't think... That was a challenging idea, was a different idea, but it nonetheless got done.

Kocherlakota: So, I think the groupthink problem is really much broader than the FOMC, frankly. I think the Fed gets a lot of critique for this, but it's really more that macroeconomics at large, really thinks about monetary policy as merely a crutch, a support, to the overall recovery pattern of the economy. And it's only... And when I first came into the committee, I really had that perspective myself. It's only later that I started to think much more about, boy, monetary policy is really pretty critical in shaping the speed of the recovery. And I just think this is a more general belief that's held among academics, about market participants, that really the economy itself is self correcting. And maybe monetary policy can speed that a little bit around the edges, but it's really just about, mainly about the recovery that the economy... The self correcting properties of the economy as a whole.

Kocherlakota: This is nothing really to do with... I don't think it's as something to do with the committee itself, this is really the general view of academic macroeconomists, and the general view of market participants. That that is how the economy works.

Kocherlakota: So, if you go back to 2009, and you ask, you see, this is pretty much my first meeting, we were asked, how long do you think the recovery's going to take? And the baseline that staff had in their request was, do you think it's going to take longer than five or six years? And about half the committee said, it might take longer than five or six years. And this is under appropriate monetary policy.

Kocherlakota: So, people had... It's simply the way that... The monetary policy is playing a supportive role, a necessary role, but it's not really the driving force in shaping the recovery. Is this making sense?

Beckworth: Yeah.

Beckworth: So it's the Fed... And I agree that I... Fed policy, in some sense, is a reflection of the profession itself, and what they view as the way to go, the way to operate. Along those lines, I want to know, did you feel, as a Fed official, and did you sense the FOMC felt pressure from Congress, from the buddy politic at large, to keep inflation low, that even though, maybe, some overshoot may have been justified, at least, theoretically, that there's just no way they could have done it.

Beckworth: Now, again, maybe certain members believed that it was important to have low inflation as well. We can talk about the SEP, the Summary of Economic Projection figures. If there were people in the Fed who wanted to do some overshoot, a little more aggressive easing, they feel pressure from the public that they couldn't do it?

Kocherlakota: So, first of all, you would definitely hear those voices. I mean, those voices were out there, but I just don't think that was a key force. I think if you look at Bernanke's speech, Jackson Hole in 2010, where...

Kocherlakota: This is a little more aggressive than maybe what you're describing, but if you remember, early in 2010, Olivier Blanchard wrote a piece for the IMF, suggesting that maybe we needed to have higher inflation targets. And most central bankers... I don't think it's because of political pressure, it's just simply, wow, that's way out there. Got a response. Because if you do that, if you raise the inflation target, then you've got... There's a whole bunch of credibility issues that are on the table, immediately, if that comes to play.

Kocherlakota: And Ben talked about that, Jackson Hole, in 2010, said that's just not on the table, or not... And I don't think it's because he was getting phone calls from Congress about it. It was simply... I took it to mean that, as a member of the committee, there wasn't support from within the committee for that kind of thing at all. So, that's different from overshooting, to be clear.

Beckworth: I'm thinking back to some examples of when he went before Congress, particularly early 2010, right after QE2 starts. He goes before them, and I remember he gets grilled. I believe Senator Corker, or maybe a few others, were accusing him of the greatest debauchery of the currency ever, and runaway inflation, when, in fact, inflation, or core PCE inflation at the time was about 1%.

Beckworth: And there's just this... Again, maybe, and I'll do it alone, and I need to go look at polls and surveys to verify this, but I get this sense that people, the public, is paranoid about inflation taking off. Their almost religiously rigid view about where inflation should be, as opposed to a more general notion of flexible inflation targeting.

Beckworth: But I understand your point, there also are theoretical concerns why you'd want to be careful going to that.

Kocherlakota: Yeah, I... What to say about that?

Kocherlakota: I think that it's... You want to separate out the views that people just came to the committee with, so to speak, and we mentioned president Fischer, and I would put myself in that mix, in 2009, and 2010, and these are early days.

Kocherlakota: I think Plata was in the same boat, and he didn't see it that unemployment was going to be a drag on inflation. The Fed had provided a tremendous amount of accommodation, and we thought there was a risk that inflation could get high. It wasn't because our congressperson was calling us about that. I mean, it was because we thought that was a real, real consideration that the economy should... The committee should take on board.

Kocherlakota: So I don't know... I never felt, in the meeting, that we had... That Congress was, or political influences were that key in... It's really more the overall intellectual influence of the academic profession is critical, and then the people who are in the markets, and seeing what's going on in markets also matter as well. And so, those two sets of voices really do matter tremendously, in terms of how the committee is seeing what's going on in the economy, and how it thinks about things.

Kocherlakota: But it's not about... I really did not... I've heard this argument from others that it's... The Fed was facing enormous political pressure not to be accommodative, even more accommodative than they were. I don't know. When I was there, I just did not get this sense that that was a major issue.

Beckworth: Well, let's segue way, then, into a paper you just did for the Brookings Papers on Economic Activities, which is, I think, a nice tie into this. And there, you argued that the board was, effectively, following a Taylor rule, and from that perspective, it was the Fed's own internal decision making process that kept it from being more aggressive. So, can you speak to the argument you make in that paper?

Did the Fed’s Adherence to the Taylor Rule Lead to Imbalances?

Kocherlakota: Yeah, so, I think when you get into the meeting, and there is a number of, obviously, that bring you a situation for everyone, really, around the table. The real question is how should you choose what you choose what you're going to be doing.

Kocherlakota: And I think that the Fed was very influenced by the Taylor rule in trying to wrestle that question. And I think it's... Largely the Fed came to it, came to these discussions, from the point of view is, what should our input, so to speak, what should our instrument be? And what is the appropriate setting, or instruments? As opposed to, are we getting back to 2% inflation, are we getting back to max employment, sufficiently rapidly? And that former way of thinking about things, how should we set our instrument, is very organized by the Taylor rule.

Kocherlakota: Now, in practice, what happened is that, I think the baseline outlook offered by staff, which is not a policy prescription to be clear, but it's a baseline outlook offered by staff, was grounded in Taylor '93. That is the rule that John originally put forward, Taylor originally put forward in his classic 1993 paper. The result of that was a very slow recovery, and in fact, inflation in the staff's benchmark forecast never got back to target. It was 1.5% five years later.

Kocherlakota: But I think that really the issue is that the Fed was not goal oriented, in the way that it thought about policy. It was really instrument oriented, and the question is, how do you set those instruments? It's all, it's driven by the Taylor rule and the near variants of the Taylor rule.

Beckworth: Almost by force of habit, everyone's thinking, they view the world through the Taylor rule, and it's hard to break from that model.

Kocherlakota: Look, there's a model that you've used, going into the crisis. It served you well, and there's a bunch of work to suggest that the pre 2007 period, that the Taylor rule was a good approximation to what you... In order to appropriate our monetary policy.

Kocherlakota: Then, you get into the post crisis period, and what are you going to turn to? And I think the answer was, that the Fed ended up turning back to its pre 2007 reaction function, as a major guide to what it was going to be doing in the policy, despite the fact that it was going to lead to very slow recovery.

Beckworth: Okay.

Beckworth: And see, this is where I still try to wrap my mind around this. So, Janet Yellen had a speech, I think late last year, where she revealed the range of estimates for the real natural interest, short term interest rate, not the long term that's revealed in the summer coming projections, but the real time, short run, natural interest rate. And then, there's a median estimate, a range of estimates. And I really wish the board would release this on a regular basis. I think it was clear communication, and thinking a lot. But that's beside the point.

Beckworth: I think it's interesting, because the data that she released showed, at the bottom of the crisis, in early 2009, that real natural rate was about -5%. I think she's mentioned this in speeches in other places as well. So, if you take that as given, and you take the Fisher equation, and you're like, okay, we're stuck at a zero lower bound, so that the nominal rate's stuck at zero. The real rate is at minus five. I mean, that argument then is, well, the Fed should have engineered, at least expected 5% inflation. And to get its rate down, in real terms, down to the market clearing natural rate level.

Beckworth: But that just simply wasn't going to happen, I mean, I still have a hard time imagining the Fed coming out and saying, we're going to temporarily raise inflation expectations to 5%, so we can get real rates down to the natural rate level.

Beckworth: But that would be the argument, theoretically. So, what prevented them? Is it this adherence, this argument that you make that they're sticking to the Taylor rule, or was it the lack of a goal orientated process?

Kocherlakota: I think that it's not as much the decision making. The challenge, I think, was not so much about where the Fed had its instruments set. It's really more about its plans in... For the removal of accommodation. For when it was going to start to raise rates, and how fast it was going to raise rates. In any model where you write down, that's a critical determinate of current outcomes. Is what is the exit strategy for monetary policy. And that is, where I would say, the Fed communicated that it was planning to exit sooner than was appropriate, and communicated faster exit, as well, than was appropriate.

Kocherlakota: And there, though, I would say that Fed was largely led by the Taylor rule... Mislead by the Taylor rule to underproviding accommodation. So, I think the way to be talking about this would have been to say that, I don't think that you were going to get down to -5%, be able to deliver a real rate of -5%. But I think you would have been able to achieve a more rapid recovery if you had communicated that that's what you were trying to achieve, and had taken actions that were commensurate with that.

Kocherlakota: I thought in September 2012, and December 2012, I thought we got to a much better place in starting to communicate about exit. Saying that we were going to be really trying to provide backing to the recovery, being explicit about quantitative markers for when we were going to raise rates. I thought all that was very valuable. And I wish we had done it earlier, I guess would be the only comment on that.

Beckworth: Okay. So, what you guys did with QE3, should have done that way back in the early period. Let me put this out there. So, you put that Brookings paper out, what we've been talking about, and some people objected to it. So, John Taylor had a post where he pushed back. He cited David Papell's work. So, David Papell and some other authors have argued the Fed hasn't been following the Taylor rule. George Selgen also pushed back, and they strongly disagree, they argue, if anything, the Fed was more ad hoc.

Beckworth: What would be your response to them?

Kocherlakota: It's true that the Fed was not required to follow the Taylor rule. But they ended up choosing, in a discretionary way, to follow something pretty darn close to the Taylor rule.

Kocherlakota: I think my response is, and my theoretical piece probably adds onto this, is that the theorem is not that any rule beats discretion. The theorem is actually a very well chosen rule, that requires a lot of information about the economy, does beat discretion.

Kocherlakota: And I think that my point is simply that using... We are always going to be using past data to try to figure out what the best rule is, and that has the potential of leading you very far astray. So, I think the idea, it's a good idea to encode some kind of benchmark instrument rule into statute, as it does in the FORM Act. Boy, that's a huge mistake.

Kocherlakota: I think we're going to really regret it when it comes time to try to respond to it. If it's passed into law, it hasn't been yet, but if it were to passed into law, I think we would be very regretful of that, because it would lead the Fed, I think, into making bad decisions, either, potentially, in response to high inflation threats. You could easily imagine the Fed wouldn't be forced not to respond aggressively enough to the threat of high inflation, because it's forced to follow this rule. Or, it would underprovide accommodation response to recessionary shock.

Kocherlakota: I think discretion, a much better way for Congress to be approaching the Fed, is simply to be insisting on much more timely delivery of specific objectives. I'll put it this way, David, you mentioned earlier that I was a CEO. One thing you learn pretty quickly is, try to tell people exactly how to do their job, is not a recipe for success. But laying out a clear set of objectives and expectations for them, that they're supposed to achieve when they have that job, that is a recipe for success. And that's what Congress should be doing with the Fed, is relaying out what they expect from the FOMC, and insisting on delivering on those outcomes, as well as trying to tell them what to do, as the Taylor rule is all about trying to tell the Fed what to do.

Beckworth: Yeah, I talked to Andy Levin, as I mentioned before, and he has an idea proposal where, every year the Fed would make an annual report where they lay out its objective for the year, and then have a quarterly report, where the Fed assesses what it's done since the last report, or since the beginning of the year.

Beckworth: And I think that that would be immensely useful, because I think one of the challenges is that, when Congress and Janet Yellen, the Fed come together, they speak right past each other. And if there was some kind of, at least, framework, benchmark, that could say, this is what we're doing, this is why we're doing it. This is why we deviated from it.

Beckworth: I know the FORM Act, to some extent, does that, and my understanding of the FORM Act is that it's... There is a Taylor rule, but the Fed could deviate from it. But your concern is, it would effectively, even though they could deviate, and explain why, your concern is that they would end up following it anyways.

Beckworth: But I guess my point of this is that, it would be nice if there was some way for Congress and the Fed to speak to each other, as opposed to past each other.

Kocherlakota: Yeah, but that's easy to achieve. If you look at the  website, the Fed should be mimicking that, and the Congress should be mimicking that. Taylor's website says, here's where inflation is today... They only have one mandate, they have two percent inflation as their goal. They tell you where inflation is today, how long they expect it to get back, and when the governor of the bank talks to the parliament, it's going to be about that.

Kocherlakota: And that's... The problem is that Congress is not... There is no common understanding between Congress and the Fed, about what the Fed is trying to achieve. And without that common understanding between the overseer and the overseen, about what the goals of the institution are, none of this is going to be fruitful.

Kocherlakota: The Fed wants... I know, as a member of the FOMC, people want to be able to choose their own goals. And that's viewed as being appropriate level of independence. I don't agree with that at all. I think that the Fed have to be independent to be able to choose its instruments, as best to achieve its goals. But Congress should be setting its goals, as representatives of the American people.

Kocherlakota: And Congress has shown no interest in this at all. So, you end up with these odd discussions between... When Chair Yellen goes to testify, about all sorts of goals for monetary policy. Congress has to be clear about what it expects, and then the Fed will, I think, then deliver on that.

Kocherlakota: I think right at the FORM Act, makes it clear that Congress expects the Fed to follow the Taylor rule. And that's a recipe that I think could lead to very bad outcomes.

Beckworth: Well, what you have the Congress designate as the goals for the Fed?

Kocherlakota: That's a great question, first of all.

Kocherlakota: I would definitely want to have a very serious conversation before we went there. But I'm very inclined to some kind of level targeting. Price level targeting, I think nominal GDP targeting should be part of the mix. I think that inflation targeting... I've grown more and more, as the Fed misses-

Beckworth: I'm with you, I'm with you.

Kocherlakota: ... Longer and longer, I think there's a lot of consideration that should be given to level targeting.

Kocherlakota: But boy, wouldn't it be cool to have Congress have this conversation? I think it'd be fantastic to have actual explicit conversation about, should we be doing level targeting? Nominal GDP targeting? Informed by, of course, input from the experts at the Federal Reserve, but also, experts from around the country in academic settings. That's the right conversation for Congress to be having, as opposed to many of the side issues that we end up hearing about it, when Yellen testifies.

Beckworth: Well, I'm very sympathetic to your goals, as you know. In theory, we should be doing flexible inflation targeting, but it seems to me, in Europe, in the US, it's more like good old fashioned, rigid, straight up inflation targeting in practice. And level targeting, I think, would make the Central Bank more accountable, because level targeting requires you to make up for past misses.

Beckworth: Let me... We have a few minutes left. Narayana, I've got to ask you one last question, and it's been making the rounds. And I'm motivated by talking about Janet Yellen's speech that she had at Boston Fed conference, and in this speech, there are several things she brought up.

Beckworth: One, that she brought up that was interesting, and Larry Summers was effectively making the same point, but she questioned the general view in macroeconomics, that, in the long run, supply sides are determined by fundamentals, monetary policy aggregate demand can have these short run effects, like you said, on the margin. But she pushed back and said, maybe an area for research is to reconsider how much effect can demand have on the supply side, so in a period like we've been in, in a great depression.

Beckworth: So, do you share that view that potential role of GDP is supply side can at least be endogenous to level of aggregates demand growth?

Kocherlakota: Yeah, I think it's... I would certainly go as far as I read Chair Yellen going, in her speech, which is to say, this is a theory that should be explored further.

Kocherlakota: Economists are very quick to divide forces in the economy to exogenous and endogenous, and I think, too often, we treat the rate of innovation and the rate of investment as being outside the purview of monetary policy. But, any model you write down, of polar factor productivity, of innovation and the economy, immediately, monetary policy will show up as being an important influence on that, because the real rate of interest, which is what monetary policy try to affect, is a key input into those decisions.

Kocherlakota: So, I was very sympathetic to that perspective. I think that if we had better demand expectations for firms, you would see more implementation, and more innovation, and you'd see faster productivity growth as result, and that would give the Fed more room to be stimulative to the economy. So, that would be a positive.

Kocherlakota: So, I was quite sympathetic to her view. I think it's not a theory that... It's a theory worth exploring with a lot more care than has been given over the last 30 years in macro, I would say.

Beckworth: Yeah. Very interesting.

Beckworth: Well, with that, our time is up. Our guest today has been Narayana Kocherlakota. Narayana, thank you so much for being on this show.

Kocherlakota: It's been my pleasure. Thanks for the great questions, David.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University.

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Beckworth: Thanks for listening.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.