As Facts Changed, Fed's Kocherlakota Wasn't Afraid to Change His Mind

December 7, 2015 5:30 PM

When Narayana Kocherlakota was interviewing for the position of president of the Federal Reserve Bank of Minneapolis in 2009, his employers asked him to keep an open mind about monetary policy. They could not have known that by the time of his retirement, set for the end of this month, Kocherlakota would have altered his views so drastically as to become the institution's leading advocate for more aggressive stimulus.

"Especially given what we were going through, the real need that was felt was, you can't come to this knowing the answers," Kocherlakota said in an interview from his offices, overlooking the icy waters of the Mississippi. "This has echoes later."

Kocherlakota began his role as Minneapolis Fed president with policy views in the hawkish end of the Fed spectrum, which tends to worry more acutely about high inflation. He said a number of developments led him to change his mind.

First, the inflation he feared might follow the Fed's large bond buys did not materialize. Second, he saw increasingly convincing arguments that unemployment had more to do with business cycle fluctuations than more intractable long-term shifts in the economy. More broadly, he just felt the central bank was falling short of its goals.

"I think the tenor of the way we interact in the committee, which is about learning from each other, building from each other's ideas—I wouldn't have gotten to the point I got to," he said. "I've emphasized chairman Bernanke, he's obviously an intellectual giant. But there were many other folks I was listening to: [Chicago Fed president] Charlie Evans, the current chair [Janet Yellen]—I learned a lot from her as well."

Kocherlakota now favors a forward-looking goal-oriented approach to policy, and argues that such a framework might have already yielded a stronger economic recovery.

Indeed, he is worried the Fed, which looks increasingly set to raise interest rates at a meeting next week, may be making a big policy error.

"It might turn out well and I hope it does. But it's a risky move," he said. "I'm not sure—to use an old expression—the game is worth the candle. I don't see the benefits as being there."

The Fed has kept official interest rates at effectively zero since December 2008, and bought over $3 trillion in government and mortgage bonds to support the economy's rebound.

"I don't see inflation coming back to target for years to come," he said. "It's not just my view. That's the staff's forecast. We have some of the best people in the world forecasting inflation for the Federal Reserve. That's their forecast."

In addition, lower inflation expectations embedded in the bond market suggests the Fed's 2 percent inflation target has become less credible among market participants.

Nor does the US job picture, while improving gradually, inspire much confidence, Kocherlakota said.

"I don't think the 5 percent unemployment rate is telling the full story," he said. "We have to take a broader vision of what full employment means. If you talk to Americans out there in the labor market and looking for work—it doesn't sound like we're back to full employment when you have those conversations."

He added: "What's going on in the labor market does not strike me as a strong argument for tightening."

Read a transcript of Pedro Nicolaci da Costa's full interview with Narayana Kocherlakota