Kashkari says Fed's interest-rate decisions can't be done by a formula

Decisions on interest rates can't be made using a simple formula, Minneapolis Fed President Neel Kashkari said Monday, wading into a debate on the Federal Reserve's power just as he's about to have a say on rates.

In an Op-Ed article published by the Wall Street Journal, Kashkari wrote that calls for the Fed to follow simple rules for rate decisions "would unduly limit the Fed's policy tools and ultimately harm the economy and in turn employment."

Kashkari, who became president of the Minneapolis Fed at the start of this year, will have a vote on the Open Market Committee, which sets interest rates, for one year in 2017.

Arguments over the Fed's policymaking scope have raged since the central bank was formed a century ago. But in recent years, battles that were confined to wonky economist journals and meetings have spilled into the realm of politics and even talk radio.

Republicans and voices in right-wing media, angered that the Fed's policy of ultralow interest rates to lift the country out of an economic crisis in 2008 and 2009 appeared in more recent years to be supportive of President Obama, have argued that interest rates should be set chiefly for one reason: to keep inflation in check. Since inflation in recent years has been low, the Fed should have lifted interest rates at a faster rate than it did, they say.

A similar debate brewed, with less political overtones, in the early 2000s over the pace that the Fed raised interest rates following the 2000 recession.

The Fed's policymaking Open Market Committee last week raised interest rates a quarter-point, the first hike since last December and only the second since 2006.

President-elect Donald Trump has said he is a "low interest rate guy," befitting his experience as a real estate developer who borrows extensively.

He also said during the campaign that low rates created a "big, fat, ugly bubble" in stock prices. And he is surrounded by advisers and media supporters who say the Fed policy should strictly focus on inflation.

Kashkari, a Republican who ran for governor in California in 2014 and was a Treasury Department official in the George W. Bush administration, wrote that he supports the broad notion that monetary policy and the Fed should play a smaller role in driving the economy. But he added that the economy is too complex for the Fed to be constrained in what it can do to help when times are bad or would too quickly tap the brakes when times are good.

He noted that investors have signaled since the election that the new Congress and Trump administration might enact fiscal and regulatory policies to spur growth. "If markets are right and that growth materializes, the last thing we will want is monetary policy on autopilot that could quash the recovery," he wrote.

Kashkari wasn't available for further comment Monday. In his first year in Minneapolis, he has also taken on banking regulations, with a study of the too-big-to-fail phenomenon that led to a policy proposal last month, and a study of the slow recovery from the 2008 downturn.

Among economists, much of the debate on Fed policymaking focuses on the so-called "Taylor Rule," a calculation for setting rates that was put forth by Stanford economist John Taylor in 1993 that involves the inflation rate and the difference between targeted and actual economic growth.

Kashkari wrote that staffers at the Minneapolis Fed estimate that if the Open Market Committee had followed the Taylor rule over the past five years, an additional 2.5 million Americans would be out of work today.

Fed Chairwoman Janet Yellen at the central bankers' conference in Wyoming this summer proposed a framework for basing interest-rate decisions on policy rules like the Taylor formula. But when the U.S. encounters an extra big recession and rates need to be dropped to near zero, Yellen said the Fed should also publicly declare rates would have to stay at that level for a long time and buy government bonds to help drive long-term rates down, a step it took in this latest economic recovery.

In September, Jeffrey Lacker, president of the Richmond Fed, said that the policymaking committee had strayed from the Taylor formulation and should get back to it.

Kashkari's predecessor at the Minneapolis Fed, Narayana Kocherlakota, also jumped into the debate in September, saying that the problem with interest-rate policy in recent years has been that the Fed followed the Taylor rule too closely.

That prompted a response from Taylor himself, who said that Kocherlakota ignored the advantage of policy rules and research showing how Fed policymakers had gotten away from them.

Evan Ramstad • 612-673-4241