You are now listening to the UR Quadcast, the official podcast of the University of Rochester.
Peter Iglinski: I’m Peter Iglinski, your host for this episode. Narayana Kocherlakota is a Lionel W. McKenzie Professor of Economics at the University of Rochester. Before joining the faculty last year, Professor Kocherlakota served six years as president and CEO of the Federal Reserve Bank of Minneapolis. He’s held academic appointments at Stanford, Northwestern, the University of Iowa, and the University of Minnesota. He’s also been active in research, particularly in the fields of money and payments, business cycles, financial economics, public finance, and dynamic games and contracts. Currently, his focus is monetary policy. Thank you for taking the time to be with us today.
Narayana Kocherlakota: It’s my pleasure. Thanks for having me on, Peter.
PI: Do you miss the economic stage that is the Federal Reserve?
NK: I miss, to a certain extent, the engagement with the policy questions. You know, working with a group of people, such an amazing group of people, on such important questions. That was a very exciting time. With that said, I’m really glad to be back in academia now. I enjoyed my time at the Fed, especially given what a state of, really economic emergency, almost, that we were in at the time I was there, 2009 through to 2015. But right now, I’m glad to be back in the halls of academia.
PI: Speaking of that, do you have enough challenges now, considering where you came from?
NK: I feel challenged all the time by having to keep up with the people in my field. That’s the challenge now for me.
PI: Now that that crisis is pretty much over, the recovery is fairly slow, but the crisis is over, so the job you’d think would be a little easier now. You went through all the hard part, so why did you leave the Fed to come to Rochester?
NK: I should go back to when I joined the Minneapolis Fed in the first place, and I always said that when I was working at the Fed that if you had asked me in 2005 if I wanted to be president of the reserve bank, I would have thought to myself, well I’m engaged in pretty exciting economic research, and I like my teaching. And the problem with monetary policy is being handled by experts; I’m glad it is. But then 2009 rolls around when unemployment is 10% and it’s clear at that point that, I felt that it was clear there would be benefits for someone with my years of expertise coming to help out, so to speak, with the response to the economic situation. I went to the Fed because the situation was hard, not because it was easy. I want challenge in my life, and right now the challenge is trying to figure out with my colleagues both here at Rochester and around the profession, how can we have a better set of models, a better set of frameworks, a better set of answers in place the next time, if there is a next time, we get into that same kind of situation.
PI: So why is Rochester the right place for your next challenge?
NK: There are a couple answers to that. This is one of the top departments of economics in the country. Beyond that I think it’s a good fit for me in terms of the environment. The research environment here, I think, is conducive to the work of macroeconomics that I want to do. Rochester has been very strong in macroeconomics. My wife and I both fell in love with the community when we came to visit. So that together—the research and academic environment are really what led me here.
PI: Good reasons. You were born in Baltimore and you’ve said though that your formative years took place in Winnipeg. What took you from the U.S. to Canada?
NK: Well I was taken from the U.S. to Canada by my parents when I was less than a year old. I suspected I didn’t have a lot of say on the decision at that point. But I grew up in Winnipeg from the time when I was about three until I went to college. I spent my years in Winnipeg. People in Rochester like to think of winter here as cold, but it’s actually not that cold in Rochester compared to Winnipeg. Winnipeg is about twenty degrees colder on average in January than Rochester.
PI: So you came to where it’s warm; you came down south.
NK: Every place I’ve lived is warm compared to where I grew up.
PI: Your parents are fairly accomplished—two PhDs—how much of an influence were they in your own education? You didn’t rebel. A lot of kids rebel from their parents.
NK: I rebelled because they were statisticians, I went into economics. That was my rebellion. In all seriousness, yeah, it was just great for me growing up to have those kinds of role models and influences on me and the support of interest in education they provided. You don’t want to think, as a child, that you’re being led by your parents’ examples so much, at least I didn’t, but of course I was, and that’s why I think I was led to academia as being a natural place for me.
PI: Your undergrad work was at Princeton, you entered at the age of 15, and then you earned your PhD in economics at the University of Chicago. It suggests that school came pretty easily to you. Did it?
NK: I don’t know, I think the sense of that it came easy is this question about my parents that you raised just now, which is that I had an incredibly supportive environment and a very education-oriented environment at home, and that made it easy for me to focus on school and get motivated to do well at school. As I’ve left my parents and had more experiences of the world, I realized what a privilege it was to have that kind of upbringing. That’s the sense in which school came easy for me because I had that support at home to facilitate that in the world.
PI: At what age did the economics bug hit you?
NK: Well that’s a good question. So when I first went to college, I was pretty interested in economics, but the really exciting teachers I had, I had some good teachers in economics, but the really exciting teachers I had were in mathematics. It’s partly luck of the draw and partly they have a great math department at Princeton. And so I got drawn into majoring in mathematics when I was there. I actually quickly realized that I didn’t want to do mathematics full time. You know when you’re experimenting, you take some math, but you’re taking other things. When I realized I was taking most of my courses in math, three out of four of them, I realized, okay wait a second, this is probably not for me. So then I started to look around for what I should be doing after I left school. I thought about law school, I actually applied to law school. But in the same time in the summer after my junior year, I remember being in the library and I picked up a book on mathematical economics by a French economist named Aubin, and that book combined higher mathematics and the public policy questions that I was interested in exploring. I had come to Princeton and had thought about economics, so the questions were there, and then the higher mathematics was also there, and that was what led me into “Okay, I’m going to go off and do my PhD in economics.” And then I went to Chicago, which was just a tremendously exciting place. That’s where I really fell in love with economics as it really is; it was at Chicago. 7
PI: Now as I had mentioned earlier, you had a number of appointments at academic institutions, and then you went to the Fed. How do you get a job as the president CEO of the Fed? It’s not the sort of thing that pops up on LinkedIn, I would think.
NK: That’s not the way I found it, no. That’s a great question. You have to back up and think about what the Federal Reserve System is like to get an answer to that. The Federal Reserve System is a very unusual organization. It’s the central bank of the United States. If you go around most countries, their central banks are located in the capital, and they operate right there in the capital. That’s not true of the Federal Reserve System. The headquarters are in Washington. But there are twelve regional reserve banks located around the country. Those regional reserve banks have a number of different functions, but one of them is that they’re supposed to really provide an outsider’s perspective on the making of monetary policy so that it’s not just dominated by political appointees in Washington or the regional bank in New York, which tends to be very markets-oriented. So the other regional banks, one of which is in Minneapolis, they attend the meetings, participate in the meetings, vote on monetary policy, but really their job is to provide this outsider’s perspective. So that’s a long-winded way to start out by saying many academically-oriented individuals have been drawn to these jobs over the years, and it’s because the problem of public policy, especially monetary policy, is really a technical one, and so people who have studied monetary policy, as I have in my academic career, are really drawn to these kinds of appointments. In the case of Minneapolis, my predecessor, Gary Stern, had been president of the Federal Reserve bank in Minneapolis for twenty-four years. Going into 2009, he became president at the age of forty-one and hit retirement age at the age of sixty-five. All of us working in the Minneapolis area, as I was—I was at the University of Minneapolis at that time—knew that Gary was going to have to retire. At that point I applied for the job and went through the process. The process is that you have to be selected by the non-banker members of the board of directors of the reserve bank. There are nine directors in total, six don’t have an affiliation with a bank. You have to be approved by them first, appointed by them first, and then approved by the board of governors in Washington. You go off to Washington and then have to interview with each of the governors of the Federal Reserve System including Chairman Ben Bernanke, to see if you’re ready for the job. Those interviews in Washington were extremely stressful, I will say.
PI: How long did that process take?
NK: The whole process started from basically April through to the end of September. It’s very thorough. There are several interviews with the relevant board of directors, probably three or four rounds of interviews there, and then you have to do these interviews that I described in Washington, with each of the members of the board of governors separately.
PI: Time for an economics 101 lesson. I think there’s a mystique around the Federal Reserve System. How much power does it have? What does it actually do, and how does that influence the economy?
NK: Well the right answer to this question is you should take Economics 211—Money, Credit, and Banking—next semester, and then you’ll be ready with all the answers to this question.
PI: Who teaches that, you?
NK: Yes, by coincidence I teach that. No, I think the Federal Reserve has a mystique about it as you described. Part of it is because, out of necessity, the decisions are made in secret, they’re carefully guarded. Part of that is to avoid influence from political influences of various kinds. One of the main goals of having a central bank like the Federal Reserve set up the way it is, is to separate it from political influences. And that’s because a lot of research and a lot of experience has shown that the more interference you get from politicians making monetary policy the worst the outcomes are. So the Fed tends to be separated from the hullabaloo that is Washington, as a result, and that, I think, builds up a mystique about it. There’s a lot of discussion among economists about how important the Fed is, meaning how important is monetary policy anyways? And it comes back to the question we talked about at the very beginning about leaving the Fed now as opposed to 2009? I think virtually every economist would agree that, in situations like 2009 when unemployment is at 10%, inflation is running very low, it’s clear that monetary policy has a major role to play. Now at a time like this when unemployment has fallen below 5% and we’re facing a much stronger economy than we had in 2009, thankfully, there’s more disagreement about how important monetary policy is. But in situations like deep recessions like we had in 2009, I think there’s a general agreement that monetary policy is a very important part of it.
PI: What do you vote on at the Fed?
NK: So the typical thing that’s being voted on is the level of short term interest rates, really one day interest rates, in the economy. That sounds, so what? One day is a very short period of time, so why should that matter at all? Well it’s really because people are forecasting how the Fed is going to set that one day interest rate, not just today, but every day into the future. If investors think that those interest rates over the next five years are going to be very high, well that’s going to make five-year interest rates high, as well. And that’s going to make it more costly for you to borrow to buy a car, for example. And this is how the Fed influences the economy. By raising interest rates, they are going to constrain demand, make it harder for people to borrow, make it more attractive for them to save. That’s going to mean there’s going to be less demand for employees by firms because they don’t have to produce as much. And that’s going to mean that there’s going to be less inflation as a result of that, because there’s less wage pressure in the economy. So raising interest rates tends to constrain demand and lower employment. On the other hand, cutting interest rates does the opposite. With that said, the Fed also has a bunch of other tools at their disposal. I just described the way I would describe monetary policies, just now to you, is the way I would have done it in 2005. The Fed has also been buying very long term assets. This is an attempt to—what happened to the Fed in late 2008 is that they had lowered the short term one-day interest rate to as low as it could go. They couldn’t lower it any more, even though unemployment is skyrocketing they really didn’t have any other way to stimulate the economy. So they engaged in the buying of longer-term assets. By buying those, what you’re trying to do is drive down long-term interest rates. By pushing up the price of those bonds, you’re driving down long-term interest rates and having some of the same influences I described to you earlier, making it easier for people to borrow to buy houses and less attractive for them to save, and that generates more demand as a result, and, hopefully, pushes down on employment and up on inflation.
PI: Now clearly there are different economic philosophies out there. Are you an economic ‘dove’? And what is that?
NK: Well, nobody wants to be classified. I reserve the right to do anything I want, but no, when people talk about monetary policy doves and hawks, I think there’s two different ways it gets used. The way people in markets like to use it refers to your stance on interest rates. If you’re favoring low interest rates, you’re viewed as a dove, and if you want to raise interest rates, you’re viewed as a hawk. Now economists actually don’t talk about it so much in terms of interest rates, they think about it more in terms of the tradeoff between inflation and employment. So I’ve just described to you that when you raise interest rates, you’re going to be damping down on inflation, which is a good thing if inflation is running too high, but on the other hand you’re going to be reducing the demand for workers, which will push up unemployment. So there’s a tension there. And the way you weigh off on the point of inflation is sometimes referred to—if you’re more worried about high inflation, you’re viewed as a hawk, if you’re more worried about high unemployment, you’re viewed as a dove. This is a long-winded way of saying, when I first joined the Fed in 2009, unemployment was very high, as I’ve described to you—near 10%. Inflation was low, but I was very worried that given how much the Fed was doing that inflation would come back very rapidly to be where the Fed’s—the Fed’s ultimate objective is to keep inflation around 2% or so. And what happened to me was that I was wrong about that. The data on inflation just didn’t conform with what I expected to happen. And so I became, I think correctly, more worried about the fact that unemployment was high, and simultaneously inflation was too low, below 2%. That made me viewed, I think, both by economists—because I was less worried about high inflation I became viewed as a dove—and by the financial markets, especially ,I was favoring low interests rates, so I was definitely a dove. I will say that since becoming a dove, I feel like I’ve not been that wrong about the economy. When I was a hawk I was wrong a lot. So I think being a dove has cohered with facts in a way that was not true about being a hawk.
PI: To be clear, you have not left the national stage. You might be gone from the Fed, but you have not left the national stage. You’re frequently interviewed by the media about economic topics. What economic issues keep you up at night?
NK: I worry a little bit about monetary policy, of course. I worry about how low inflation has remained in the U.S. What do I mean when I say that? The Fed is targeting 2%, that is its goal for inflation, and inflation has been running more in the low 1% range. That doesn’t sound like that big a gap, but it means that if the Fed faced a recession, that lower inflation would actually represent less capacity for them to be able to help the economy. It would mean that people would face less of a stimulus to spend to help us get out of a recession, if inflation is as low as it is. So that is a concern to me. On the financial regulation front, I’m probably even more concerned. There’s a real push to roll back a lot of the regulations that were adopted in the wake of the financial crisis in Washington. I think you always should be reevaluating what you’ve done, but I think those regulations have, by and large, made us safer in terms of lessening the probability of a crisis, and that’s a good thing. The final thing that keeps me up, when I do think about this, is I think the Fed’s reaction to this crisis in 2008, which was to really bolster the financial system in a number of different ways, and I wasn’t part of the system at that point to be clear, it wasn’t my decision, it was Chairman Bernanke and a number of others who were supporting him. I thought those moves were remarkable, important, and critical. The situation would have been much worse had the Fed had not acted as it did. Yet I see a lot of skepticism, both on the left and the right, in Congress about letting the Fed have the ability to act in a future crisis. I think that that’s a cause for real concern that would make any future economic crisis much worse than what 2008 was.
PI: Now the Fed’s decisions, and your work in the Fed, and even your work now, affects the public, which to me begs the question, how would you gauge the public’s economic IQ?
NK: I actually have a lot of information about this. I described how I travelled around the ninth district of the United States, and I spoke to a number of people about economics. I think that people are reasonably sophisticated in the way they understand the economy. I think there are genuine trade-offs that we face, genuine tensions in how we make policy. If you spend more now, that generally means that you’re going to have to finance that by borrowing or by raising taxes, and borrowing means you’re going to have to raise taxes sometime in the future. Those are the tensions that we have to struggle with and live with, and it’s not really a lack of understanding that is the problem. The one thing I think gets overplayed in the press and leads to confusion by the public as a result, is the notion that there’s waste in government spending. There is waste in government spending. But the orders of magnitude involved in that waste are just so small compared to the kind of debt and deficit challenges we are facing, not today, but we will face in ten to twenty years as people in our society age. We’re going to face more of a commitment in terms of Medicare spending, social security spending. That’s going to create more of a deficit. That’s the big challenge facing the US. And I think because of the emphasis in the media coverage on waste in government spending, people come away with this idea that “oh if we could just fix the waste, we can take care of all these other problems.” I’m in favor of fixing waste, don’t get me wrong, but we’re probably two orders of magnitude, three orders of magnitude, off in terms of trying to fix our deficit problem that’s coming down the road.
PI: You’ve been critical of the slow economic recovery. What should have been done differently?
NK: I think that people were overly concerned about inputs and not sufficiently concerned about outputs. Now what do I mean by that? We face this issue of high unemployment, 10% unemployment in 2009. And a lot had been done already. Interest rates were very low at that stage. The Fed had already gone out and bought some assets, we had already had a round of fiscal stimulus from the federal government, we’d had enormous interventions from the financial system. So a lot had been done. So there was this feeling that “alright, boy, haven’t we done enough?” I think that was focusing, as I say on the input side, on what had been done? As opposed to, I think, taking more of the tactic of, no, unemployment is still too high. It is unacceptably high. We should still be doing more. And I think that was the challenge within the Fed. Frankly, it was even more of a challenge in Washington. It was a huge challenge in the capitals of Europe. And it led to a slow recovery around the world. And unfortunately, I do think that slowness to the recovery has had a permanent scarring effect on our own economic standards. It’s a depressing thing to think about.
PI: You wrote early in 2016 that economic policy makers can, and must, do better. What do you mean by that?
NK: I meant at that time that I thought that employment remained too low and inflation remained too low. The cost of trying to do more to stimulate higher employment would be high inflation, but there was no sign of high inflation. Now, that was 2016, now we’re well into 2017, but I honestly think that I might not be quite as aggressive in saying what I would say, but I would still believe that we could do better. And the reason for that is inflation remains low, and we expect inflation to remain low, so there’s still room. There’s no–the fact that inflation remains low tells us that we’re not bumping up against resource constraints, we’re not bumping up against–there’s still underemployment, of resources out there in the U.S. In particular, our human resources remain underemployed. You know, you’ll hear businesses complain about scarcity of labor, but then the question should be, “Why aren’t you raising wages?” We still aren’t seeing the wage growth that I would view as being healthy enough in the U.S. And it’s when we get that wage growth, when you get that price growth and inflation, that’s where we’re going to be able to say, “Okay, this is as good as we can do.” Until we see that, I think our public policy makers can, and should, do better.
PI: Is that what you meant by, “the need for an easier fiscal and monetary policy”?
NK: So this is the beginning of 2016, it was the beginning of the political campaign–or not the beginning, obviously–but we were hitting into the heart of the election year. And I was trying to make the point that I think politicians should have been willing to speak in favor of large infrastructure spending. That would have been the easier fiscal policy I was thinking about. So, spending on roads, on building new hospitals, and people talk about airports, rail lines, there are a bunch of kinds of projects that you could talk about. And I was suggesting that that would be a good course for candidates for president to espouse. On the monetary policy front, I thought that the Fed had just raised interest rates at the end of 2015 for the first time in seven years. I thought that that was a mistake. They had planned to raise rates four times in 2016, and they only ended up doing it once.
PI: You’ve also been a big supporter of greater diversity in economic models, so tell us what that all means.
NK: Yeah, so, in the public eye, most of the attention is on macroeconomics. To be clear, economists have been on the microeconomic side, have studied how different policies would affect African-Americans from whites, Hispanics versus whites; there’s a lot of work on that micro side. On the macro side, we’re just starting to begin to use what people call heterogeneous agent models, which respect the fact that different people have different circumstances. But you’ll still see, I think, insufficient attention to differences in economic outcomes based on sex—so men versus women—and there’s virtually no work in macroeconomics which is respectful of the fact that economic outcomes for African-Americans are systematically different than for whites. Now why does this matter? So one thing that matters a lot is, how does a recession affect a given person? How does the risk of the recession affect their decision to save versus spend, in particular. Well, if you think to yourself that people are only facing the average amount of risk, you’re missing the fact that actually, the risk of being unemployed in a recession is actually much lower for white Americans than it is for African Americans. And so you’re going to be exaggerating, if you’re looking at whites you’re going to be exaggerating how much risk they face, and if you’re looking at African Americans you’re going to be underestimating how much risk they take. And that can affect your modeling of consumer demand, and affect your model of the macro economy, as a result.
PI: See maybe I will take your course, because you’re explaining this perfectly. It just makes total sense. Why isn’t everybody doing this?
NK: Partly, it’s the relevant data has only started to become available. If you start to say, “I want to look at African Americans as a group,” say by spending, the number of data sources we had were relatively small, and that leads to sampling error, as a result. So that’s one–I don’t think it’s a particularly good justification, but it is one justification. We are starting to get more of the data available by population, so large data sets that actually cover huge swaths of the U.S. And I think you will see more work of this kind done as we move forward, but my experience at the Fed would make me say, “Boy this is something that we want”—I wanted to see, and my staff wanted to see in Minneapolis—and there really hadn’t been enough done.
PI: When you’re not being kept awake with these economic issues, how do you relax?
NK: Yeah, so my wife and I, one reason we came to Rochester is because we love the classical music scene here, going to the RPO, going to Eastman concerts. It’s also great for hiking and that kind of thing, and we have a couple of dogs, and so we’re kept pretty busy walking them, and there’s a lot of great dog walking to be done in this neighborhood.
PI: Now being an internationally regarded economist, what would surprise people the most about you?
NK: I’m a lot better at foosball than probably people think I am. A lot better.
PI: I’ll stay away from you on the foosball table. Professor Narayana Kocherlakota, thanks for being with us today.
NK: Thanks, Peter.
PI: My thanks also to Joe Hagen, our audio engineer. For the University of Rochester Quadcast, I’m Peter Iglinski.