Don't Fear the New Boss at the Minneapolis Fed
Narayana Kocherlakota is out at the Federal Reserve Bank of Minneapolis and Neel Kashkari is in. Is there some rule that the president of the Minnesota Fed must have the initials "NK"?
Well anyway, in the meantime, let's think about what Kashkari's appointment means for the Fed.
First of all, Kashkari, a former Treasury official, isn't obviously the liquidationist -- a foe of government intervention during financial crises -- that some of my econ blogging colleagues have made him out to be. Paul Krugman raised this fear, based on the following Kashkari quote from Twitter:
Growth was artificially fast due to leveraging of econ. Trying to return to that rate thru def[icit] spend[ing] is futile.
But this view isn't outside of the bounds of standard economic theory. If growth was above potential in the mid-2000s because of a bubble, it makes sense to say that demand-side policy won't be able to return us permanently to the growth rate we enjoyed during those years. Of course, muted inflation during the housing bubble years might challenge the notion that growth was above potential, but that is a separate issue. Kashkari is basically just saying he thinks growth was above trend, which isn't really a liquidationist position.
University of California-Berkeley economist Brad DeLong, meanwhile, is worried that Kashkari is an unreasonable hard-money hawk. This is based on tweets in which Kashkari called monetary stimulus "morphine." But although Kashkari may be a hawk, the "morphine" analogy isn't necessarily a bad one. Monetary policy -- indeed, all demand-side stabilization policy -- does provide a temporary boost, like morphine.
But is it addictive like morphine? Some people believe that the Fed's low interest rates cause "expectation anchoring," so that companies come to believe that zero interest rate policy is permanent. If this happens, the economic penalty from raising rates from zero may be increased -- much like withdrawing from morphine. So if Kashkari is just talking about expectation anchoring -- and it does look like he is -- then his analogy makes sense.
So I doubt that Kashkari is either a liquidationist or a crazy monetary hawk. Instead, his comments reveal him for what he is -- a non-economist. Kashkari is an engineer with an MBA, which makes him stand out in an institution that is dominated by people with doctorates in economics.
That lack of economics training means that Kashkari will tend to express himself in language that's different from other Fed officials. People who have been through economics graduate school speak in the official cant of the profession. Instead of "addiction" we say "anchoring," and so forth. People who don't use this argot run the risk of being perceived as cranks by the academic econ community.
But this isn't a reason to fear Kashkari. A non-economist will actually be a welcome outside voice in an institution stocked with academics. What's more, it could even improve Fed communication, since the general public doesn't speak in economics jargon.
It is probably true that Kashkari is somewhat of a monetary hawk. But even if so, he'll be swimming against a general dovish tide at the Fed. The brief flowering of dovish sentiment at the Minneapolis Fed caused by Kocherlakota's legendary conversion could never have been a permanent change, since the Minneapolis Fed's board -- which chooses the president -- is the same as before.
So does Kashkari come with any downsides? I do see one. Kashkari was involved in creating the Troubled Asset Relief Program -- also known as the government bank bailout of 2008. As assistant secretary of the Treasury for international economics and development under Henry Paulson, Kashkari helped draft and administer the program that bought $700 billion in troubled mortgage-backed securities directly from the nation's megabanks.
Many people, me included, believe that some sort of bailout was necessary. But many also believe that TARP was too soft on the banks, since top management was left in place and given no penalty for getting the country in trouble. Many fear that the no-strings-attached nature of the bailout created what economists call moral hazard -- an implicit guarantee of future bailouts that will end up encouraging banks to take excessive risk during the next bull market. Others suspect the government of giving favorable terms to politically connected institutions, particularly Kashkari's former employer, Goldman Sachs.
Now Kashkari, the TARP guy, is at the Fed. That could cause some negative optics for an institution that is already under heavy political attack, mainly from the right. Kashkari's hawkish instincts will probably not be enough to exonerate him in the eyes of the conservative activists who want to hobble or even end the Fed, and his background at Treasury may give these activists some rhetorical ammunition.
But in any case, it's too early to tell what Kashkari's appointment will mean for the Federal Reserve system or for monetary policy. The economics media will be watching with interest.
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