Neel Kashkari, Interview: Sioux Falls Business CEO Event

Fed Funds

“And so, there’s a lot of attention to the next meeting in March. Is it going to be 25 or is it going to be 50? I’m open-minded at this point about whether it’s 25 or 50 basis points. To me, what’s much more important than whether it’s 25 or 50 is what we signal in what’s called the dot plot.”

“Given what the data that we’ve gotten in the last month which has been a very strong jobs report, higher inflation that we expected, I mean, these are concerning data points suggesting that we’re not making progress as quickly as we would like. At the same time, we shouldn’t overreact to one month’s data even if the data is troubling.”

“So to me, whether 25 or 50 is less important than what the dots look like. And at this point, I have not decided what my dot is going to look like but I lean towards continuing to raise further that I would continue to push up my policy path. We’ve got another inflation reading yet to come. We have another job report yet to come before the meeting. Ultimately, that will inform me but I think the bottom line is I think where the dots end up is going to be much more important than whether we raise by 25 or 50 at the next meeting.”

Terminal Rate

“So, in December when I jotted down my dots, I dot jotted down that I thought we would get rates up to 5.4% and then hold them there for an extended period of time. And I was on the more hawkish distribution amongst my colleagues. I was not the most but I was on the more hawkish side.”

Inflation Expectations

“So, if you looked at the forward say 10 year inflation expectations, they have been anchored throughout the pandemic. They’ve just little tiny wiggles around that 10-year line. That’s comforting because it means they’ve got a lot of confidence that we’re going to do our jobs over a 10-year horizon.”

“Then short-term inflation expectations did rise quickly. They have fallen quite a bit.”

“So, we look at a lot of different indicators. Financial markets are not perfect. So, if you looked at the inflation expectations three years ago, financial markets also didn’t see the high inflation coming. So, we pay attention to it but we don’t take too much signal from it because markets can be wrong, too. And we were all wrong about this high-inflation shock at the same time.”

Balance Sheet

“So, our balance sheet got really big during the pandemic as a source of first providing some financial stability to markets, but also providing stimulus to the economy. And now, we’re doing what people call QT. We’re shedding our balance sheet, letting it run off and shrinking it actually very aggressively about twice as fast as we shrunk it after the last financial crisis. And so, that is also putting some upward pressure on long-term treasury rates.”

“So, you can think of it this way. There are two ways right now that we are tapping the breaks in the economy. One way is we’re raising this federal funds rate where we just talked about it, whether a 25 or 50 basis points at the next meeting. Then second way is we’re letting our balance sheet shrink and that should be putting some upper pressure on long-term rates. Those are both ways that we are, in effect, reducing stimulus or tapping the brakes in the economy. That’s going to continue now for quite a while because our balance sheet is still quite large relative to where it needs to be.”

Recession

“Now, whether we can achieve the soft landing, the answer is I don’t know. The track record is not good in being able to slow down the economy this much without going a little too far and heading into recession.”

“But the dynamics are different. We have supply chains that are getting better. We do have families that have strong balance sheets. We do have states that have strong balance sheets. There are a lot of really healthy things going on in the US economy right now that give me some optimism. But at the same time, we know we need to get inflation back down. So, I don’t know the answer to that.”

“I will say, typically, when the central bank has caused a recession by raising interest rates, the bounce back can be very fast. So even the great terrible recession in the early 1980s engineered by the Volcker Fed to crush the high inflation in the 1970s, the recovery was brisk. It was a very rapid recovery as opposed to the recovery from the great financial crisis which was very, very slow.”

“So, I don’t know how comforting that is that the recovery can be very quick but we have to get inflation down.”