Robert Kaplan on the Fed’s New Framework, Inflation, and the Post-COVID Economy

Robert Kaplan is the president and CEO of the Federal Reserve Bank of Dallas. Previously, he was a professor and Associate Dean at Harvard Business School, and prior to that was a Vice Chairman of Goldman Sachs. Robert is a returning guest to the podcast, and he rejoins Macro Musings to discuss the Fed’s new framework, inflation, interest rates, and more. Specifically, David and Robert talk about COVID’s impact on FOMC operations, how demographic trends are impacting productivity, the Fed’s expanding balance sheet, its average inflation targeting framework, and more.

Read the full episode transcript:

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: Robert, welcome back to the show.

Robert Kaplan: Thanks, David, good to be with you.

Beckworth: Well, great to have you on. I've been looking forward to this chat with you for some time. Once it was arranged, I've been excited to talk with you. Talk about the new framework, all the details, learn as much as I can from you on it, but before we get into that, I'm just curious. How has the Federal Reserve fared under the pandemic, in terms of operations? How has your life changed, FOMC’s procedures changed because of the pandemic?

COVID’s Impact on FOMC Operations

Kaplan: So it won't surprise you that we've got a certain number of people who don't have an option to work remotely. People in cash, some of our facilities, many of our law enforcement. So we've got some fraction of our people who've been coming in every day. I've been coming in every day. At the same time, anything we can do remotely we've been doing remotely, and that includes the Federal Open Market Committee meetings. So the great bulk of our people are working remotely and doing so very successfully, in research, supervision and community outreach and a whole range of other activities. So we've adapted like a lot of businesses have, we've adapted reasonably well.

Beckworth: Do you see any permanent changes moving forward? So once we're out of the pandemic, the virus is long gone. Do you see permanent remote working arrangements for some staff?

Kaplan: I mean I think through this experience, like also we're hearing with a lot of our business contacts, we're going to be more comfortable doing some things remotely that we used to do in person. That may be yeah, adapting to people's desires to work more remotely. Certain meetings we did where we traveled and met in person, we might actually conclude it's very effective to do those meetings remotely, including with the public. So yeah, there'll be a whole number of changes I could see, where we've just gotten more comfortable and realize that it might be extremely effective to do something remotely that we used to think we had to do in person. So we've learned a lot.

Beckworth: Yeah, so even the Federal Reserve is affected by the pandemic in ways that many of us have experienced it ourselves.

Kaplan: No question.

Beckworth: I have to ask this question though, about the FOMC. Part of meeting or having a committee to get together is the dynamics when you're in person. Some personalities are more prominent than others, the chance to chime in, to say your two cents worth. It's got to be different doing it via Zoom or Skype, however you do it. So has that changed the dynamics in a meaningful way or do you feel you're still able to do what you would do in person?

Kaplan: So it's interesting, the actual meeting itself runs basically the same. In other words, we each speak about economic conditions, we each speak about our recommendations for monetary policy, and we have debate and discussion. I think what you lose is the breakfast together, lunches together, dinners together, and scuttle bet in the hallway between times during the formal meeting. I think that is very, very valuable, but the meeting itself if you looked at the minutes of in-person meetings versus remote meetings. My guess is they're going to look very similar. It's what happens in between meetings and the relationships you build doing all these things for a couple of days between meetings that I miss and I think are beneficial.

Beckworth: Yeah, well that makes sense. I think a lot of us can relate to that in our own walks of life. I just think of going to conferences. You go to the conference to hear a good paper, a good idea presented, but you also go to a conference to network, to see friends, to stay connected, to chit chat on the side. I think a lot of us are missing that. So that's interesting to hear at the Federal Reserve, same thing.

Kaplan: Definitely.

Beckworth: Okay, let's move from the Federal Reserve and how it's been affected by the pandemic, maybe to the broader economy. I'm just wondering, because I know you think a lot about technology, innovations and how it affects productivity, growth, and ultimately the economy. Do you see any long lasting influences from the pandemic? Any changes that'll be with us going forward?

COVID’s Impact on Technology, Innovation, and Growth

Kaplan: Yeah, I mean for starters, technology, technology enabled disruption was accelerating pre-pandemic. I would say the pandemic has increased the level of acceleration [of technology enabled disruption]. Why is that? Because a lot of things previously we didn't think we could do through technology, we now realized we can. There have also been many people, including people like me, who just always liked to go buy things in person, didn't like to buy things online as much, where we didn't have a choice in the pandemic. Now that we're used to shopping or doing business remotely, realize, you know what? It's that I can now get why everybody did that.

The pandemic has increased the level of acceleration [of technology enabled disruption]. Why is that? Because a lot of things previously we didn't think we could do through technology, we now realized we can.

Kaplan: The need for travel I could see will change, in that people will still travel but for business, I think we've now explicitly gone through and say, gee this type of meeting, does it really make sense to use half your day or all day or spend the night to achieve that meeting when you could do the same meeting remotely for a fraction of the time? So I think I see that myself, and I'm seeing it broadly among business people that I talk to. So I think people will make those trade-off decisions differently because they realize now that using technology and doing things remotely is much more viable than they thought.

Kaplan: By the way, you talk to universities. I used to be, as you know, a university professor. While we did some things online, I would say there was a lot of resistance. What we found was across universities in the spring of 2020, that resistance just went away because professors realized, I don't have choice. If I want to teach, I've got to do it remotely. So the whole academic field just made a leap forward in remote learning. They didn't intend to, but they did in anyhow. So I'm sure there'll be long lasting changes as a result of that. So that's the whole range, those are the things I can think of off the top of my head. There'll be a whole range of these activities that will not switch back.

Kaplan: There'll be some things that do rebound back, but the world will look different.

Beckworth: Yeah, I like that. I recently had another guest on the show, Caleb Watney and he is making the case or made the case that we're going to see really strong gains in productivity growth. So there's this idea of the great stagnation, productivity growth slowed down from the '70s, picked up a little bit in the early 2000s, late '90s, but it's been relatively flat. He listed all these technologies, things that you've mentioned, the new vaccines for example. Just the whole pandemic being a catalyst to bring online all the innovations we already had but just hadn't widely used. So I'm hopeful, and I want to believe that total factor productivity growth with accelerate moving forward, which is good for monetary policy among other things because that will help push up r- star, make your job easier over the long run. So I'm very hopeful for that.

Beckworth: The one thing that I'm still worried about, and this is based on a conversation with the previous guest on the podcast, is the demographics in the US. So let's say we do get productivity gains, our population growth rate has fallen. We just got numbers out from the Census Bureau, 2020 of course was very unique but the lowest population growth ever, as long as they've kept records. Even before the pandemic, fertility rates were going down, population rates going doing, and that is an important input to production as well, is having the bodies. So how do you feel about that?

Demographics and Productivity

Kaplan: So let me comment on all of that. First of all, going into the pandemic, here's what we were finding. If you had a college education or greater, it was very likely that technology was making you more and more productive every year. I'm sure as a result of this pandemic, you can amplify that statement, but we also have a working thesis here at the Dallas Fed, if you've got a high school education or less and you work in a job that maybe requires personal services, personal contact, technology may not be as accessible to you but the big issue is, let's say you're a call center operator. Those jobs are being disrupted and eliminated due to technology. Unless you get retrained, the next job you're in may actually have lower total factor productivity and maybe a lower value added job, and it will show up in your lower income. There are 46 million workers in this country with a high school education or less.

Kaplan: So the reason we hadn't seen bigger improvements in productivity is for a chunk of the population, they're more productive, businesses are more productive, but our thesis here is for high school educated workers and less, productivity might be causing their job to be restructured or eliminated. It's not necessarily aiding their productivity. Our solution to that was, improving educational attainment, literacy, and beefing up skills training to allow people to migrate to these more technology accessible jobs.

The reason we hadn't seen bigger improvements in productivity is for a chunk of the population, they're more productive, businesses are more productive, but our thesis here is for high school educated workers and less, productivity might be causing their job to be restructured or eliminated.

Kaplan: Now to your point, if we improve productivity... So I don't know, we might be surprised that productivity jump isn't as great as you'd think because of the way it affects different workers differently.

Beckworth: Fair enough.

Kaplan: The second thing to your point, I'm convinced there are going to be plenty of jobs. There was a skills gap going into this, there's going to be a skills gap coming out of it. There are plenty of jobs in this country, the issue is how to help our workforce become more adaptable so they can go to where the jobs are. I do think out of this, I hope, out of what we've been experiencing in the last years now, the pandemic, I would love to see a renewed commitment to overhauling our education system, starting with full-day pre-K versus half-day pre-K, having a higher percentage of kids starting 1st grade reading at grade level. Improving, beefing up skills training as an alternative to college. Maybe you go to college after skills training. We've got to improve the whole ecosystem to really get the gains that technology could offer, but again, I think there'll be plenty of jobs for people but we have to make our human capital much more adaptable.

There was a skills gap going into this, there's going to be a skills gap coming out of it. There are plenty of jobs in this country, the issue is how to help our workforce become more adaptable so they can go to where the jobs are.

Beckworth: Okay fair enough. So what is your outlook then, in terms of monetary policy? So let's step back from this conversation. In terms of productivity growth, population growth, all those things contribute to the long run, equilibrium rate or R-Star. Do you see over medium to long term, these fundamentals being tailwind and pushing R-Star back up a little bit from where it's been?

Kaplan: As we approach full employment and our price stability objectives, yes we do believe here at the Dallas Fed, R-Star will be drifting upward in the same way it's actually drifted up from March to today. It's drifted up somewhat, and we think as we recover it will drift up further.

Beckworth: But how much? I'm not asking for a precise number, but just in general terms. We've been seeing a long downward trend. Are we talking about back to pre-2008 levels or just marginal gains?

Kaplan: So I'm always mindful of the two big trends or the biggest one, aging of the population and slowing workforce growth. For me, I've said many times that the number one driver of lower interest rates overall and therefore lower R-Star, all things being equal, is aging of the population and slowing workforce growth. That trend isn't going away. After we get through recovering from this pandemic, and we'll have above trend growth probably for at least a couple of years. We're going to still have to deal with that issue. Aging of the population, slowing workforce growth, it's going to continue. Then the question is, will productivity growth be enough improvement to offset that? If it's not, you're going to have sluggish R-Star in the out years also.

The number one driver of lower interest rates overall and therefore lower R-Star, all things being equal, is aging of the population and slowing workforce growth. That trend isn't going away.

Beckworth: The Fed will be faced with that challenge if that's the case. This is a nice segway into the next topic I want to cover with you, and that's the Fed's new framework. The average inflation targeting framework that was introduced last year in August. It was announced in August, you have talked about it with your fellow committee members for a long time leading up to that, a lot of discussion. I want to start maybe with a very basic question, and we can dig down deeper, but what do you see this new framework accomplishing?

The Fed’s New Framework

Kaplan: So in the past as we approached full employment and achieving of our dual mandate goals, but particularly as the labor force got tighter and we started to approach full employment, we would anticipate inflation was coming because historically that's what happened. What we found over the last five or 10 years as we approached full employment, I think because of again, technology, technology enabled disruption and to some extent, globalization, inflation was more muted. We learned that even though we got to a much tighter labor force, inflation remained muted. With that learning, what we found was, we could run the economy hotter and have a more inclusive labor force and get in underrepresented groups back into the labor force. I think by having a stronger labor force, you can have a stronger economy.

Kaplan: So we memorialized that in the framework where we're not going to be preemptive on inflation and we're going to take more risk as we approach full employment, and allow inflation to run not only at 2% but moderately above 2% for some time. So, what do I hope would come out of that? A more inclusive labor force, a stronger labor force. I think as a result of that, a stronger economy.

Beckworth: Okay, do you like framing this in terms of a makeup policy? When you talked about, you're not going to preemptively tighten, you let it run hot, but you could think of this also as a makeup policy, making up for past misses.

Kaplan: I don't. I'll speak for myself. I don't, but again, it has a little bit to do with my... So there's two aspects of this. One, if people know we're not going to be preemptive and if we've been running below, we're going to be willing to average moderately above 2%, that should on the one hand help firm inflation expectations because people know we're serious and we're not going to surprise them.

Kaplan: On the other hand, at any point in time, I'm a big believer that you want to look forward. What's happened the last couple of years may not necessarily be indicative of what you should be doing in the next two years, but that's a little bit of a businessman's perspective, where I'm trained to understand the past, be aware of it, but make decisions based on the future.

Beckworth: Okay, fair enough. So you have a slightly different vision of it than say, the Vice Chair, Richard Clarida has. He talked about this recently in a speech as a watered down form of a temporary price level target. So you view this from a different perspective? Or not?

Kaplan: Well, I don't know about... Well, I think by definition by saying I'm willing for inflation to run moderately above for some period of time, by definition there is a little bit of an averaging in there. Let's face it, the way we currently do inflation, there's always been an averaging period. Meaning, if I say that I want the 12-month PCE target to reach 2%, by definition, that's averaged over a period of 12 months. That's a 12-month average. So the idea of averaging and a little bit of embedded makeup, that's not new. It's just a matter of degree, but am I uncomfortable with the concept? No, it's already embedded a little bit in what we do. I just, my bet will be... I'm expressing some desire to be balanced about it and to be forward-looking too.

Beckworth: Fair enough. Okay, let me tell you how I think about this, and you can put me in my place here. I am a big fan, and maybe you know this, of nominal GDP targeting. I know you've got an economist there, Evan Koenig, I know fairly well.

Kaplan: Evan Koenig has been, he's convinced me of the merits of that too.

Beckworth: Well, fantastic. So here you heard it, folks. President Kaplan also likes nominal GDP targeting. Okay, so I think we both agree on that point. So here's the question that I wanted to get to is, can you view this framework as a step in that direction, towards something like nominal GDP targeting?

Kaplan: I guess you could, but I don't know about that. So by the way, for your audience, the reason I liked, conceptually, the idea of nominal GDP targeting. What Evan Koenig has said is the beauty of nominal GDP targeting is he's pointed out that when growth is strong but inflation is a little bit weak, you can still meet your target. Okay, or conversely, when growth is a little slower but inflation is higher, that's also another way to reach your target. He's made the point to me many times that nominal GDP is what pays the bills. It's not real GDP, it's nominal. I don't think of my annual income as real, I think of it as nominal, and so that's the appeal of it.

Kaplan: I don't know that this framework is necessarily a strong step toward that. I think it's targeting inflation independently, saying I want it to reach an average that runs moderately above 2%. It doesn't necessarily speak to along with that, a specific growth rate target.

Beckworth: I agree with what you've said there, but is it also possible to look at the running the economy hot as a temporary running hot of incomes as well? So inflation is the symptom of underlying spending in income. In fact, I think one of the ways to sell the new framework in a way that consumers and firms alike is to sell it as, look, we're not here to raise inflation, per se. It will happen. What we're here to do is to restore your nominal income, to restore your nominal spending. Temporary inflation's a byproduct of that. So to that extent, you are a very soft version of nominal income targeting, although it's not called that.

Kaplan: Yeah, listen, one of the big challenges for the Fed to your point, is how to explain why low inflation is something you want to be concerned about. I think the public understands why low growth is something to be concerned about, and understand why high inflation is something to be concerned about. I don't know if it understands or views low inflation, particularly if it's accompanied with solid growth, as something you should be concerned about. I think in fact, many people out there would say that's a good thing. So we've got some communication challenges with that.

Kaplan: One of the things I liked about nominal GDP targeting is it helps, as you said, put it all in context and explain why nominal incomes, in terms of servicing government debt or individual incomes, why nominal incomes is a good thing to be paying attention to.

One of the things I liked about nominal GDP targeting is it helps, as you said, put it all in context and explain why nominal incomes, in terms of servicing government debt or individual incomes, why nominal incomes is a good thing to be paying attention to.

Beckworth: Yeah, now you're going to have another review if I understand correctly, in five years? Is that right? To go back and evaluate?

Kaplan: I think we've said conceptually that this is the kind of action that should happen, plus or minus every five years. I don't know if we formally said that, but I think a number of individuals have said it. I don't know if it's formal policy, but I think that's a reasonable approach.

Beckworth: All right, so let's say for the sake argument, we do revisit this. So we don't know for sure but let's say we do. Would nominal GDP targeting be on the table at that time?

Kaplan: I think when you do a framework review like the one we just did, I think you want to put viable concepts on the table, whether you adopt them or not. So I think it's always healthy to look at other policy options and approaches that have merit.

Beckworth: Okay, one last question about the framework, and this gets into the specifics and maybe you can't share all this with me, but one of the questions many observers have is, what are the parameters of the average inflation targeting framework? So when we talk about running the economy hot, how long do we run it hot, or how much of a tolerance do we have for inflation being above? Is there some threshold where we get nervous and dial back?

Kaplan: So on these issues we've been deliberately vague and this is a function of the Federal Open Market Committee to be making these judgements as we go. What I've said up to now publicly, is when I say moderately above 2%, I mean moderate. So what does that mean to me? There's no exact science, two and a quarter, two and a half, for me means moderate.

Kaplan: Then the second thing I would say, and which is why judgment at the time is going to matter, if we saw inflation gradually firming, one eight, one nine, one nine five, two, two one, then I would have one reaction function. If on the other hand I saw a situation where inflation was growing rapidly and we reached a certain arithmetic average but it would be because we've had a very rapid rise in inflation, I could see I might very well have a very different view as to how we ought to deal with that from a monetary policy point of view. So I think your trajectory is going to matter a lot, and the other facts and circumstances that accompany it.

Beckworth: So when you're making that evaluation, do you look both at the forecast of PCE as well as the actual measure? What weights would you put on each one, relatively speaking?

Kaplan: I will look at that and a whole range of other things. I want to see how the overall economy is doing, I want to understand labor force dynamics, and all of the other aspects that we look at, at understanding the overall economy. At this point in advance, I wouldn't put a weight on it. I would deliberately not put a weight on it. Here's why. I always remind myself, what are we trying to do? Full employment and price stability. So I always go back to that. Are we achieving full employment but price stability? We happen to pick numerical benchmarks for price stability, but the thrust is you want price stability. So I think that's always worth emphasizing, for me at least.

Beckworth: Let me ask the question this way. So assuming all the other markers are on track, things are looking good, the economy's recovering. You see inflation forecasts hitting 3% and maybe current inflation is still 2.2, 2.1. Does that concern you? I mean, should we be looking, when we're thinking of the framework, should we as outside observers also be looking at forecasts, whether market forecasts, consensus forecasts?

Kaplan: So I've said again, sitting here now, I'll reserve the right to make that judgment then, but for me, moderate, moderately above means I would say where I'm sitting it's different than other people around the table might say. Two and a quarter, two and a half, for me means moderately above.

Beckworth: All right, fair enough. Moving on. Let's talk about inflation then in general. So if you look around the advanced world, and you alluded to this earlier. Prior to the pandemic, inflation in all the major advanced economies was trending down, or not trending down but below target, and it was persistently that way. What is your understanding for why that has happened? Not just in the US but in Europe, Japan, and other places like that.

Managing Inflation

Kaplan: So a few factors. One, again, is the dramatic acceleration and technology replacing people around the world. The dramatic rise in platforms that use technology or technology enabled, and limit pricing power of business. Then related to those first two, globalization. That increasingly if you're going to buy a good or a service, you can shop and think about it globally.

Kaplan: So other factors might include aging of the population in advanced economies, but when you wrap that all up together, I'd say the trends have been for innovation and globalization to be limiting pricing power of business. That is, to extent you get wage pressure, it's as or more likely to turn into margin erosion, as you are to be able to pass it on in higher prices.

The trends have been for innovation and globalization to be limiting pricing power of business. That is, to extent you get wage pressure, it's as or more likely to turn into margin erosion, as you are to be able to pass it on in higher prices.

Beckworth: What does that imply for the ability of central banks then to hit their inflation targets? Are they limited?

Kaplan: It tells me there are two conflicting forces. There's cyclical forces that are very susceptible to monetary policy, and those normally are things like how tight do you run the labor force? The tighter the labor force and the more wage pressure you create, and other factors that cause strong growth, that stokes the cyclical forces. Then you've got this structural headwind of technology, technology enabled disruption and globalization that's not susceptible particularly to monetary policy. It might even be accelerated by low interest rates because a lot of these technology platforms are fueled with low cost capital, and that lengthens duration of investment horizon while fuels those platforms. Those two forces are conflicting and we're going to have to see in the future how they play out, but that force of technology and technology enabled the disruption and globalization is not going away and it's having some muting impact to help offset to at least some extent, the cyclical forces.

Beckworth: Okay, so you have these other exogenous forces out there that's affecting inflation in advanced economies, but at the end of the day, who is the final arbitrator or determiner of inflation? I mean, can a central bank confront these shocks, these developments, and offset them meaningfully so that they can hit the 2% target?

Kaplan: I'll speak for myself, but the jury's been out on that. How the fact of the matter is, we don't control the structural forces. I think we've got to... I'd rather approach it, we need to learn from this dynamic. So you may know, we do a lot of work here at the Dallas Fed on this trend. We've done two conferences, we'll do a third in May, which you're invited to attend.

Beckworth: Well, thank you.

Kaplan: We're trying to encourage more research and better understanding of how these two forces are playing against one another because no, I think only a portion of these forces are susceptible to monetary policy, and some of them just aren't. I think we're better off recognizing that.

Beckworth: How about macroeconomic policy for generally? So we've touched on central banks, but let's throw is fiscal policy. Can fiscal policy work in a complementary fashion with monetary policy so that 2% targets are hit?

Kaplan: Yes.

Beckworth: Okay.

Kaplan: Yeah, so there's two ways that fiscal policy and other parts of the government can. One, fiscal policy has a big impact obviously on building the cyclical forces, but number one, investments in early childhood literacy, education, investments in skills training, investments in wifi, greater availability of wifi. These are all things that may not necessarily take the government, but they're structural reforms. Immigration policy, trade policy, these are all structural policies that can have a big impact and yes, monetary policy should be ideally complementary to those policies. When we see these structural impediments, I also think that central bankers can do a service to call them out.

Investments in early childhood literacy, education, investments in skills training, investments in wifi, greater availability of wifi...Immigration policy, trade policy, these are all structural policies that can have a big impact and yes, monetary policy should be ideally complementary to those policies.

Beckworth: Okay, so you mentioned earlier the structural forces that have been pushing inflation down, they're with us and they're going to continue to be with us moving forward. If anything, maybe they've been intensified because of the pandemic. What's different though I think moving forward, in terms of policy, has been the large fiscal response. I mean the Fed's also been very aggressive, but this large fiscal response, has it been enough do you think, between the two, the Fed and the fiscal policy? Has there been enough to push us back up to 2% over the medium term, in terms of inflation?

Kaplan: We'll have to see. I mean, the honest answer is we're studying it very carefully. I think you're going to see by the way, in the short run over the next year, you're going to see some supply outages, integrated supply chains and some logistical issues with semiconductors, metals, lumber products, packaging products. I don't think those are going to be persistent, I think they're going to be transitory, and over time those will get resolved but I think our own approach here at the Dallas Fed is to recognize that, our theory of pricing power. I think we'd be wise to add a strong dose of humility, understanding that this is a dynamic that's changing and we'd be wise to call that out and work harder to try to understand it and encourage research that better understands it.

Beckworth: Okay, would you want any additional tools given to the Fed? Maybe some fiscal tools, like helicopter drops or direct Fed accounts or maybe make use of yield curve control, negative rates? Are there any tools you would add in order to help the Fed get to its inflation targeting, in an ideal world?

Evaluating the Fed’s Toolkit

Kaplan: I mean my own belief is I think we've got appropriate tools, including some of the tools you just mentioned. I think the onus will always be on us. At this point, I think we have sufficient tools, the onus will be on us to use our best judgment on how to deploy them, understanding that one other factor we haven't talked about yet is financial stability. In particular, I'm thinking about excesses and imbalances that can be created oftentimes in the non-bank financial system, as well as in the economy that we've got to be tracking and mindful of.

At this point, I think we have sufficient tools, the onus will be on us to use our best judgment on how to deploy them.

Beckworth: Okay, so let me throw out a scenario. Why not use aggressive, negative interest rates, yield curve control and then deal with the financial instability issues with more macro prudential tools?

Kaplan: Yeah, so I'm not a fan of negative interest rates. I've studied and we've studied here how they've been used around the world. I can see the negative effects and the damage they can do to the financial system, particularly in the United States, what they would do. Particularly given we need many companies here reliant on commercial paper, which depends on a strong money market industry. I think when you have negative rates, you could do some negative damage to financial intermediaries, which may have unintended consequences. I haven't seen the offsetting benefits to my satisfaction to offset those risks.

Kaplan: I also, as you probably heard me say, unless in extraordinary circumstances, I'm hesitant to do things that can distort market signals. So you mentioned a couple of tools that would involve distorting the yield curve, and I think in extraordinary cases you may find it appropriate to do it, but again, it's not free. It's not without costs. So I'm sensitive to these issues, that is, we pursue our dual mandate objectives, there could be unintended consequences if you go too far in use of tools, which might appear to be helping you reach one objective or both objectives, but can have side effects. Some that you can see and some that are a lot easier to see in hindsight. That's the problem with these side effects, they're a lot easier to recognize in hindsight. As a businessperson who spent his life in the markets, I'm extremely sensitive to that.

Beckworth: Those are all great points, and I'm broadly sympathetic with them. I mean, I think it is important to preserve the incentive for financial intermediation, preserve that spread so that firms are willing to engage in it.

Beckworth: Let me ask this question, if there were a way to preserve the spread between the cost of lending versus investing, so some for example, have suggested dual interest rates. In Europe, they have these TLTRO’s which keep banks profitable but give them the incentive to lend to the real economy. Would you be open to something like dual interest rates? I think the way it would work here in the US is, you would keep interest on reserves at some level where it is, and you would lower discount rates really low, maybe even negative. Then you'd require, if banks tap into it, they would have to lend it to the real economy. I know the devil's in the details in that because all kinds of opportunities for arbitrage and other tricky behavior, but I wonder, is there any discussion about dual interest rates at the Fed or any interest? I haven't seen much.

Kaplan: No, I would say my approach would be to be open-minded about studying, and if these options, studying them. But again, I'm very cognizant that things that you may do to distort markets, distort market function, may ultimately have unintended consequences. My own view is, it would be healthier, at least over time if we can for the US economy and the markets, to wean off some of these extraordinary measures. I think we'll be better off in the long run when we get to the point we can wean off some of these extraordinary measures. Certainly, I'm very concerned, or skeptical, and will scrutinize and study them, but will scrutinize anything that I think might distort the market function or market signals.

I think we'll be better off in the long run when we get to the point we can wean off some of these extraordinary measures. Certainly, I'm very concerned, or skeptical, and will scrutinize and study them, but will scrutinize anything that I think might distort the market function.

Beckworth: I think that's a great skepticism to have because we know from history, it's once you get into some of these exotic tools it's hard to get out. I mean, the Fed Accord was not an easy thing to work through, but that's what it took to break the peg the Fed had on treasuries. I think in Japan, you can see there's a danger with yield curve control there. Once you get in, it's hard to get out.

Kaplan: Yeah, and I think Japan's a good example. I lived there for five years and Japan has some very challenging structural issues. Their aging issue is actually worse than the United States, more pronounced, so that we expect their population is actually going to shrink. Okay, they have not been historically very receptive to immigration. They do have a big foreign worker program, but it's not enough to offset the aging issue. So in that regard, monetary policy can have an effect to a point but it's not going to make up for the fact you've got real structural issues and those issues need to be addressed, and ultimately, it might be healthier to address those issues.

Beckworth: Absolutely, address the actual issues, as opposed to a symptom of it through some fancy, exotic tool at the central bank. Fair enough.

Kaplan: That's right.

Beckworth: All right, well let's move on to the last thing we want to cover today, and that is the Fed's balance sheet. So it's been growing rapidly, before the pandemic it was roughly $3.5 trillion, now it's over $7 trillion. I know you've commented recently on this, you want to leave the purchases as is, but I have maybe a broader question then that – the timing or how you do it?

The Fed’s Expanding Balance Sheet

Kaplan: While we're in the teeth of the pandemic.

Beckworth: In the teeth of the pandemic, okay. So you're open to news and data as it comes forward, absolutely.

Kaplan: Yes, we have an outcome based benchmark for when we said we're going to keep those purchases of $80 billion and $40 billion going, until we make substantial further progress. That's an outcome based measure and I'm going to be very outcome oriented and avoid being rigid or predetermined as to when we'll meet that outcome.

Beckworth: Okay, what I would love to hear about is the size of the Fed's balance sheet. Does it bother you that it's gotten larger? I mean you mentioned earlier you're concerned about interventions in the markets, if we go negative rates or yield curve control. I mean, as the Fed's balance sheet gets really, really large, there's more and more reserves sitting at banks, it crowds out money markets. Any concerns there moving forward?

Kaplan: So I mean I've learned, I've been at the Fed since the fall of 2015 and I've learned in that period, it's easier to grow the balance sheet than it is to diminish it. It's easier to do these extraordinary things, it's challenging to wean the economy off of them. In that regard, I've said that after we've gotten to the point where we've weathered this pandemic and we've got it firmly in the rear view mirror, I think the US economy would be much healthier if we could wean, an appropriate way, wean off some of these extraordinary measures. So my view on the balance sheet is, we've done what we've had to do as a result of this extraordinary pandemic. While we're in the teeth of it, and until we've weathered it, I think we should be aggressive using all our tools, but once it's clear that we've weathered it and the pandemic is in the rear view mirror and we're making substantial further progress toward our dual mandate, I think it would be very healthy for us to wean off some of these extraordinary measures. So I think we'll benefit in the long run. I think we'll have a stronger, more resilient economy if we do.

My view on the balance sheet is, we've done what we've had to do as a result of this extraordinary pandemic. While we're in the teeth of it, and until we've weathered it, I think we should be aggressive using all our tools, but once it's clear that we've weathered it and the pandemic is in the rear view mirror and we're making substantial further progress toward our dual mandate, I think it would be very healthy for us to wean off some of these extraordinary measures.

Beckworth: So how far would you see this weaning going? So as you know, and I believe we discussed this last time you were on the show. The Fed adopted a floor operating system or what some call an ample reserve system, and the alternative is a corridor operating system. Kind of what the Fed had before 2008, although that was an asymmetric one, but I look north at Canada. Canada's had a corridor operating system where it has very few reserves. How far would you want to go? I know part of the challenge here is the new regulations, post Dodd-Frank, which made it difficult for the Fed have complete flexibility, given these new regs on bank requirements, but if you could have your way, would you want to stick with a floor operating system or would you like to try out a corridor operating system?

Kaplan: I would say that for the foreseeable future, I think it's likely we're going to be in an ample reserves regime, for a whole range of reasons. So I think it's likely we're going to be with a floor system for quite some time. So I think that's the reality I think for the time being.

Beckworth: No, for sure. This is almost an academic question because I realize in the limit, maybe…

Kaplan: I probably won't even go there. I think given the situation we're in and given what we're doing currently, I think we've got our work cut out for us to operate in an ample reserves regime for some period of time.

Beckworth: Okay, well with that, our time is up. Our guest today has been Robert Kaplan. Robert, thank you so much for coming back on the show.

Kaplan: Thank you, David. Great to talk to you.

Photo by Brendan Smialowski