This blog post accompanies the SDPB Monday Macro segment that airs on Tuesday, November 8, 2022. Click here to listen to the segment, which begins at minute 19:00. And for more macroeconomic analysis, follow @NSMEdirector.
On Wednesday, November 9, at 7 pm in the SDSU Oscar Larson Performing Arts Center, Minneapolis Federal Reserve Bank President Neel Kashkari will sit down with me to discuss inflation, the labor market, the economy, and what it all means for the role of the Federal Reserve today. The event is free and open to the public; no registration is necessary. Neel Kashkari began his career as an aerospace engineer. Later, after earning a graduate degree in business, President Kashkari joined Goldman Sachs in San Francisco, where he worked several years. His career in public service began in 2006, when he joined the U.S. Treasury under then-Treasury secretary (and former Goldman Sachs CEO) Henry Paulsen. In 2008, he became assistant secretary of the Treasury, overseeing the Troubled Assets Relief Program (TARP) during the financial crisis. President Kashkari assumed his current role at the Federal Reserve Bank of Minneapolis at the start of 2016. In this blog post, I discuss the role of the Minneapolis Fed in the contexts of the Federal Reserve System and the U.S. economy—an ideal setup for Wednesday evening’s conversation, which everyone reading this post will attend, of course.
Mervin King, the former governor of the Bank of England, famously quipped that monetary policy should be boring; this is to say, monetary policy should not distort otherwise-optimal free-market outcomes; when it comes to monetary policy, there should be nothing to see here. Indeed, in theory, monetary policy is boring: according to the first fundamental theorem of welfare economics, complete markets, complete information, and perfect competition together yield Pareto optimal outcomes absent policy interventions. We may not desire the distribution of these outcomes, but monetary theory is largely silent on remedies. Of course, as Monday Macro listeners know well, in practice, monetary policy is not boring; essentially, money matters because the assumptions underlying the first fundamental theorem do not hold uniformly. Put differently, the societal impact of monetary policy is not trivial. Thus, advancing knowledge in this field—as in all others we study in the Ness School of Management and Economics—improves the quality of life for residents of South Dakota and beyond.
In monetary theory and policy, we often categorize central bankers as either hawks or doves—birds of prey or otherwise. Essentially, a hawk prefers low and stable inflation at the cost of real economic performance, if necessary; for example, a hawk prefers a rate of inflation consistently near two percent even if this means the unemployment rate hovers consistently above 5 percent. Doves prefer strong real economic performance at the cost of low and stable inflation, if necessary. Determining a central banker’s ornithological profile is not easy to do, in part because few central bankers reveal their preferences clearly and unambiguously. One exception is Neel Kashkari, who is well known for speaking his mind on matters of monetary policy and otherwise. For the last several months, President Kashkari has been relatively hawkish; this is somewhat of a change in stance for Kashkari, who had been arguing, prior to the onset of our current high rates of inflation, that interest rates should be kept relatively low through the pandemic. Speaking to the Wharton Club of Minnesota in Minneapolis this past August, Kashkari remarked, “By many, many measures we are at maximum employment and we are at very high inflation. So this is a completely unbalanced situation, which means to me it’s very clear: We need to tighten monetary policy to bring things into balance.”
Broadly speaking, Kashkari’s reasoning, like the reasoning of most macroeconomists concerned about our current circumstance of high and somewhat-variable inflation, is that although the Federal Reserve has been rather aggressively raising interest rates over the last several months, interest rates—and, specifically, real interest rates—remain too low relative to the performance of the U.S. economy. Essentially, the current level of interest rates in the U.S. economy seems too low relative to the current (nearly closed) output gap and the (positive and large) inflation gap. More importantly, the real interest rate—the nominal interest rate adjusted for the rate of inflation—remains negative. Thus, credit conditions and monetary policy remain too loose. Loose monetary policy stimulates aggregate demand and, in doing so, fuels inflation. To quell high inflation, the Federal Reserve must raise real interest rates; this is to say, the central bank must raise nominal interest rates and, simultaneously, lower expected and actual inflation.
The role of the Minneapolis Fed in the contexts of the Federal Reserve System and the U.S. economy is multifaceted. But before explaining that role, we take a quick trip down memory lane in downtown Minneapolis.
The Minneapolis Fed has been around the block—a few of them actually.
The Minneapolis Fed has been around since the founding of the Federal Reserve System in 1913, when Congress passed the Federal Reserve Act. And since then, the Minneapolis Fed has occupied five addresses in downtown Minneapolis. The first two addresses housed the Minneapolis Fed temporarily, when the reserve bank consisted of relatively few employees. The Minneapolis Fed opened on November 16, 1914, headquartered in the Minnesota Loan & Trust Co. on Marquette Avenue and 4th Street. By January 1915, the reserve bank occupied the The New York Life Building on Second Avenue South and Fifth Street, where the bank remained until 1925. The first building intentionally constructed to house the Minneapolis Fed was located on Fifth Street and Marquette Avenue, where the reserve bank opened for business on January 1, 1925. In Illustration 1, I picture the Minneapolis Fed; the base structure of the building, which now vertically spans several stories, essentially remains in place today.
Decades later, the Minneapolis Fed found itself once again cramped for space, leading to the second building intentionally constructed to house the bank—the revolutionary suspension building still located at 250 Marquette Avenue and pictured in Illustration 2; readers familiar with downtown Minneapolis no doubt recognize this now iconic feature of the city.
Ultimately, the Minneapolis Fed outgrew its home on 250 Marquette Avenue, leading to the third building intentionally constructed to house the bank—its current location on Hennepin Avenue and First Street North, overlooking the Mississippi River (and the much-loved Grain Belt Beer billboard across the river). In Illustration 1, I picture the reserve bank’s current location.
The Minneapolis Fed is, like, a branch of the Fed, right? Nope.
The Minneapolis Fed is one of twelve so-called reserve banks that together comprise, along with the Board of Governors located in Washington D.C., the central-banking system in the United States. This is to say, unlike the Bank of Canada or the Bank of England or the Bank of Japan, the Federal Reserve System is a system of independent central (reserve) banks—quasi-public government agencies, each of which controls a fundamental monetary-policy tool—or instrument, in the parlance of monetary theory: namely, the discount window. Banks seeking to borrow bank reserves—think, vault cash—from the lender of last resort do so at a reserve bank’s discount window; it’s a metaphor, the literal windows are no longer in service. The Minneapolis Fed serves, in this monetary-policy capacity and otherwise, the ninth district of the twelve-district Federal Reserve System. States in the ninth district includes Minnesota, Montana, North Dakota, South Dakota, the Upper Peninsula of Michigan, and northwestern Wisconsin. The twelve reserve banks are quasi-public—and, thus, quasi-private—because each reserve bank is owned by the member banks in the corresponding Federal Reserve System district. For example, the equity in the Minneapolis Fed is owned by member banks in the ninth district. These banks determine six of the corresponding reserve bank’s nine directors, who, in turn, appoint the reserve bank’s president—Neel Kashkari, in the case of the Minneapolis Fed.
Generally speaking, the monetary-policy reach of a reserve bank such as the Minneapolis Fed is larger than the effect the bank has on the monetary base through discount-window operations—lending as a last resort. Indeed, truth be told, banks—think, borrowers—rarely avail themselves of the discount window, in large part because doing so reveals a borrower as one in need of a lender of last resort, a stigmatized distinction to be sure. As a practical matter, then, a reserve bank and, specifically, its president, exercises the greatest monetary-policy reach as a member of the Federal Open Market Committee (FOMC), which consists of the seven members of the system’s Board of Governors and five reserve-bank presidents: the president of the Federal Reserve Bank of New York, who serves as vice-chair of the FOMC, and four other reserve-bank presidents appointed to the board on an annually rotating basis. Currently, Minneapolis Fed President Neel Kashkari is a non-voting member of the FOMC. He was last a voting member in 2020; he will regain that status in 2023. In any case, every reserve-bank president participates actively during each FOMC meeting, in part because each meeting is informed by each reserve bank’s assessment of the corresponding district’s economy. This information is contained in the so-called Beige Book, a district-by-district report, published eight times per year—once for each FOMC meeting—covering current economic conditions in each district.
Essentially, the FOMC sets the target for the federal funds rate, which is the (interbank) rate that banks charge each other for bank reserves—inventories, essentially, that banks manage in order to generate earnings (by lending reserves to borrowers) and to maintain liquidity (by storing reserves for cash-seeking depositors). To move its target, the FOMC directs so-called open-market operations, through which the Federal Reserve Bank of New York purchases debt securities—such as Treasury bonds—on the secondary market (to lower the target for the federal funds rate) or sells debt securities (to raise the target for the federal funds rate). As Morning Macro devotes know well, the FOMC—and, thus, the Federal Reserve—rather precisely targets the federal funds rate; thus, at any moment, the rate reflects the so-called stance of monetary policy: expansionary—and a relatively low federal funds rate—if output is below potential or inflation is below the two-percent target rate; or contractionary—and a relatively high federal funds rate—if output is above potential or inflation is above the two-percent rate. The central bank’s dual (Congressional) mandate of maximum employment (and, thus, output at or very near its potential) and stable prices (and, thus, low and stable inflation) informs this tactical feature of monetary policy. Since November 2, when the FOMC last met, the FOMC’s target range for the federal funds rate has been set between 3.75 and 4.00 percent. In Figure 1, I illustrate the monthly federal funds rate, which the FOMC has very intentionally sought to increase since the start of this year.
As Figure 1 illustrates, in the aftermath of the 2008 financial crisis and COVID-19, the FOMC lowered its target for the federal funds rate to essentially zero, or what became known as the zero lower bound. Lower bound because the FOMC chose not to impose negative nominal federal funds rates on the banking system and, thus, the economy.
Finally, although the monetary-policy role of the Federal Reserve System, including its reserve banks, understandably captures the public’s attention, the system engages the U.S. economy and society in other ways too. For example, in the last several years, the Minneapolis Fed published its Minneapolis Plan to End Too Big to Fail, the culmination of a yearlong study of the moral-hazard problem that a government safety net—actual or implied—creates; and more recently, the Minneapolis Fed has focused its attention on racial disparities and inequality—two features of the U.S. economy that President Kashkari has strongly emphasized. For example, the Minneapolis Fed houses the Center for Indian Country Development, which “supports the economic prosperity of Native nations through actionable research, policy development, and community collaboration,” and the Opportunity and Inclusive Growth Institute, which “conducts and promotes research that will increase economic opportunity and inclusive growth, and help the Federal Reserve achieve its maximum employment mandate.”
Mervin King quipped that monetary policy should be boring precisely because it is not. The Federal Reserve System and its role in the U.S. economy are fascinating topics. The opportunity to spend an hour discussing these topics with a leading U.S. central banker is priceless—the sort of stuff only the Ness School offers.
See you on Wednesday, November 9, at 7 pm in the SDSU Oscar Larson Performing Arts Center.
One thought on “bird watching”