Neel Kashkari on Interest Rates, Inequality, and Government Debt

Barron’s: The

S&P 500

index, the

Dow,

the

Russell 2000,

and Bitcoin are at new highs, while bond yields have plunged. The Fed has created a thorny problem for pension funds and others.

Neel Kashkari: I don’t know that we have created a thorny problem. Our job is to try to achieve our dual mandate of stable prices and maximum employment. We still have 10 million Americans out of work, relative to January, and inflation continues to be below our 2% target. [Inflation in November was 1.2%.] If we saw a modest uptick in inflation, I think we would call that success. We’re watching the data very carefully and taking appropriate action. What’s the alternative? We should raise interest rates to try to keep the stock market from climbing higher and, in doing so, keep more Americans out of work? That seems like a lousy trade.

The Fed controls interest rates in the short term; the global economy sets interest rates over the long term. Interest rates all around the world over the past 20 or 30 years have been gradually declining. It’s not because of central banks. It’s because of broader macroeconomic forces, such as the balance between savings and investment, demographics, and technology development. If we said, “Well, let’s just go raise rates because we feel higher rates are ‘normal,’ ” that would put the economy back into recession. It would keep workers on the sidelines. How is that going to help pension funds?

The Fed’s firepower this year included lots of lending facilities. How successful have they been?

They’ve been very successful at keeping this health-care crisis from becoming a financial crisis. I applaud our chairman, Jay Powell, for leading us aggressively in March, when the economy shut down and there was a very real risk of having a full-blown financial crisis.

Some of the actions to support small and midsize businesses have been less effective than we would have liked. That’s because of the nature of the crisis. For example, the Main Street lending program to provide low-cost loans to midsize businesses has gotten a lot of attention. A lot of businesses said, “Look, we don’t need a loan; our business has been shut by the pandemic. How can I take on more debt right now? I need a grant.”

The Paycheck Protection Program that Congress created was very effective in getting money to small businesses. The key feature of that is, those are forgivable loans if you meet certain criteria. We’ve used the powers we have aggressively, and they’ve been effective in stabilizing financial markets and keeping credit flowing. At the end of the day, this is a health-care crisis, and it’s going to be the vaccines and scientists and doctors and nurses who get this crisis behind us.

You oversaw the Troubled Asset Relief Program during the 2008-09 financial crisis. Recently, you asked big investors to push for more banking reform, including higher capital ratios. Do you think banks should be broken up?

I haven’t called for banks to be broken up; I said that’s one of the options that should be looked at. What I ultimately proposed was much higher capital requirements on the biggest banks [specifically, an increase to 24% from 13% today] so they can endure their own risks and cover their own losses. That might lead some banks to choose to restructure themselves or break themselves up so they don’t have to have these high capital requirements.

The banks will say, “Look how resilient we were during the Covid crisis.” That’s misleading. How did people pay their car payments, their rent, mortgage, credit-card bills? If Congress wasn’t generous with assistance, the losses would have been borne by the banks. So the banks are disingenuous.

In March, we saw a near-term collapse of the short-term credit markets. Banks and nonbanks, industrial companies, borrow from short-term overnight money markets. Why do these markets exist? They allow for key funding in good times. Why should a blue-chip industrial fund itself overnight when tomorrow its funding could dry up and all of a sudden the central bank has to step in, just so it can eke out a few extra basis points of profit? That seems silly to me. One more point: Community banks, the small banks in America, are much more highly capitalized than the giant banks. And yet the small banks don’t pose a systemic risk to the economy. How does that make any sense?

Minnesota has some of the largest social disparities in the country, highlighted by the pandemic and George Floyd’s killing. The Minneapolis Fed recently convened a summit on racism and the economy, in concert with the Atlanta and Boston Feds. Why is this an issue for central banks?

In the history of the Federal Reserve, the focus has been on the median, instead of looking at the disparities. In recent years, we’ve started to look at different experiences in the labor market. We should be aggressive in how we think about what role we can play. I don’t think we can use interest rates to target one racial group or one geography, because you set rates for the nation as a whole. But a deeper understanding of what different groups are experiencing can make us smarter and more effective as we think about the optimal policy for the country.

For five years, I argued that we were misreading the labor market—that rate increases were assuming we were at maximum employment, but there were still workers who wanted to work but didn’t find jobs. Guess what? It turned out to be true. We were surprised in 2018-19 by how many workers came off the sidelines. If we do a better job of getting more intel, more insights from diverse communities, we will be better at assessing if we are at maximum unemployment and not raising rates prematurely.

In what other ways can the Fed create more inclusiveness?

One, we supervise banks and make sure they treat all their customers fairly and equally and give everybody equal access to credit. We just updated our Community Reinvestment Act regulations, to be aggressive in making sure banks are providing credit fairly.

Two, there’s our research. In 2017, the Minneapolis Fed launched a new research center, the Opportunity and Inclusive Growth Institute, to tap the power of our Ph.D. economists to come up with potential solutions. Some we might be able to implement ourselves. Many will require Congress. A tangible one is a specific piece of legislation [proposing a civil right to a quality education]. We think that could be transformational to education over time.

You’ve said you weren’t concerned about rising government debt caused by the pandemic. Why not?

The U.S. government has extraordinary debt capacity. We have the capacity to support our fellow Americans, individuals and small and midsize businesses, until we get this pandemic behind us. That’s different than saying, “Hey, I’m going to have unlimited government spending forever.” No. 1, this is a wartime investment we’re making. No. 2, something curious happened when the pandemic hit: The savings rate took off.

Let’s say there are two sectors of the economy: the one where you and I work, and the restaurant sector, which shut down. We used to support the workers in the restaurant sector by going to restaurants, so in a way, they were our employees. Now, we aren’t going to restaurants. Their incomes have gone to zero, and our savings have gone up. When you and I save more money, we put it in the bank, and it ends up going to the bond market. So, through our domestic savings, we have the capacity to support these workers. The fact that our national savings rate went up in this crisis shows that there’s this pool of excess savings in our economy available to support workers who’ve been laid off.

What is the incoming Biden administration’s role in addressing the pandemic?

Working with Congress to get as much assistance as possible to individuals, families, small businesses, and the states. States should be doing localized lockdowns, and the federal government should be providing generous assistance to those affected by those lockdowns. If the Biden administration and Congress can make sure the fiscal assistance is there, then governors may have more willingness to say, “We’re going to take the hard medicine and save lives.” Then, when vaccines are widely available, we can reopen safely. [In an email to Barron’s after Congress passed a major stimulus package this week, Kashkari said, “I applaud Congress for passing more Covid relief. It will help provide a bridge until vaccines are widely available.”]

You’re a Republican who ran for governor of California and lost to Jerry Brown. How would you heal this country’s political divisions?

Americans of all parties agree on lots of things. Education of kids is one. Infrastructure is another. One issue that’s big in our region is rural broadband. As a country, we ought to decide that every American deserves the right to high-speed internet. I’ve written publicly about the need for a reformed immigration system. Right now, there are a lot of laid-off Americans, but when we get this pandemic behind us, we’re going to need more workers to feed our economy.

Thanks, Neel.

Write to Leslie P. Norton at [email protected]