Interview With a Fed Dissident: The Sole Vote to Raise Interest Rates

Esther George at the Central Exchange in Kansas City last year. She became president of the Kansas City Fed in 2011.

Esther George is a dissident, at least by the standards of the Federal Reserve. Since becoming president of the Kansas City Fed in 2011, she has repeatedly cautioned that the central bank is trying too hard to stimulate growth, and that its policies may cause lasting economic distortions instead. Last month, at the most recent meeting of the Fed’s policy-making committee, she cast the sole vote in favor of raising interest rates. It was her 10th time voting on policy, and the eighth time she has opposed the consensus of her colleagues.

Yet Ms. George’s disagreements are modest, matters of degree. In an interview earlier this week, she said she just wants the Fed to do a little less, to retreat just a little faster. “This is not a time to try to cool an overheated economy,” she said. “We’re not trying to fight inflation. For me it is really beginning to move slowly and on a path that allows this economy to adjust.”

Ms. George, whose district includes a swath of America’s oil and gas fields, said she had been surprised by the pain caused by lower oil prices. Yet she remains more optimistic than some of her colleagues about the short-term prospects for economic growth even as she worries more than they do that the Fed’s efforts to spur growth will eventually prove counterproductive.

Ms. George, who worked for years as a banking regulator, also talked about her frustration that the government – including the Fed — had not yet taken the necessary steps to ensure large banks could be safely dismantled.

We spoke on the top floor of the Kansas City Fed’s 14-story headquarters, the newest in the Fed system, opened just before the 2008 crisis. The interview is edited for clarity (and we cut some stuff because your time is valuable).

Q. Why did you dissent at the March meeting?

A. I understood the rationale around what had changed since December in terms of the global economy, the financial market volatility we had seen. But my focus is really on, since the start of normalization in December, how had the outlook changed: whether those things should be incorporated into that outlook or simply monitored as we went forward. And I came out on the side of saying we should continue our gradual normalization by making another small move in the Fed funds rate. The gradual process is designed to allow us to accommodate these uncertainties and some of the risk out there.

Q. So you don’t see evidence these problems are weighing on growth?

A. I think the issues that are affecting our growth are the ones we saw in December. A strong dollar has cooled our net exports, we’ve seen inventories stay elevated and for some time we’ve seen weaker business investment. But at the same time our labor markets have continued to add jobs at a healthy pace, we’ve seen the consumer continue to be willing to spend. So those factors suggest to me that the balance of risk had not shifted in a way that I would have altered my outlook at that point. And my sense was we were moving at gradual pace in a way that allowed a lot of accommodation to remain. We’re not at risk right now of tightening. This is not a time to try to cool an overheated economy. We’re not trying to fight inflation. For me it is really beginning to move slowly and on a path that allows this economy to adjust and put rates closer to where the economy is performing.

Q. But what is the case for raising rates now? If you’re not worried about inflation, why the sense of urgency?

A. My concern is whether we’re creating imbalances that we can’t really see today. When you have rates this low, of course money flows to interest-sensitive sectors. We saw that with commodities; you can see it with real estate. And the question is, for the long term, is that allocating capital where you should in a market economy? Right now it’s heavily influenced by very low interest rates, but that may not be the most innovative or productive uses.

As I look historically at when policy has gotten off track, I think it is that desire, which I absolutely understand, to wait for more certainty. You want to see that the economy is on as stable a footing as it can be. But historically those waits can be costly. And I think we should not forget what costs they bring. And that’s really my point. I don’t want to derail a recovery by any means, and I’m not looking for high interest rates in this country, but I also don’t want to ignore the cost of moving quickly or of waiting until you’re trying to play catch-up.

Q. You warned about these risks in your first speech, in 2012, and you’ve regularly repeated those warnings. Do you see signs you were right?

A. Extending durations on balance sheets as a way to get yield, listening to savers tell me that they’re putting all their money in the stock market – those kinds of distortions are not healthy for the long-run growth of the economy and you don’t know what spring they might trigger.

I think about how we thought about subprime mortgages, how we did our best to try to add up that relative to a big market — and we kind of missed the point. There were other things going on there.

I tend to focus more on what are the conditions that you can put in place that allow those kinds of things to happen. I think today we have some of those conditions, which are super-low rates and a desire to try to overcome those either with returns or allocating your resources.

Q. You said in December that the Fed had waited too long to start raising rates. Are we now even further behind the curve?

A. We won’t know if we’re behind the curve until it’s actually too late. But the economy began to move out of recession in 2010. It hardly seems like we’re moving early when we see that we’re near full employment.

Q. Let me ask you about the explanations offered by people who think the Fed should wait to raise rates. Are you worried inflation is too low?

A. Inflation is 1.7 percent; the Fed’s target is 2 percent. In an economy this big with as many moving parts, it looks like we’re pretty close. And so I don’t wring my hands too much. We don’t have a dial where we can fine-tune where we can say I’d like to heat it up just a little bit more but not too much. I think we’re O.K. right now. I think we’re in a good place.

Q. What about the argument that the Fed can do more to help people find jobs?

A. I am completely sympathetic. People that do not have jobs or can’t earn a wage that takes care of their family, that is a critical issue. I also am reminded as I hear people describe this sense that “Zero interest rates can fix my problem,” that from the crisis going forward the Federal Reserve has become somehow the answer to many problems far beyond what we can actually address. What I think will be in their best interest is that we don’t whipsaw the economy in a way that promises prosperity only to have something come back. Raising rates quickly could cost more jobs in this country. I wish I could fix all of it with a tool like monetary policy, but we can’t.

Q. We’ve seen an increase in labor force participation in recent months. Is it possible that the Fed underestimated how many people might want to return to work as the economy improved?

A. It could have been. There’s always slack in the labor market. Trying to judge how much is never easy. The people that we’ve seen come back in, this is great news, but it’s not clear how deep that pool will be. We’ve seen the highly educated come back in. How strong will the economy be, or what has to happen to bring back others, I have more questions about that. Because it looks to me like we’re starting to get into some of what I would call the structural issues: Do people have the skills to meet the demand for the jobs we have? I don’t know how much more slack you will see.

Q. Where do you see signs of structural issues?

A. When I visit businesses in our region, and this has been true for a couple of years because remember the unemployment rate in our part of the country has been considerably lower, people are trying to find skilled labor, like welders. Businesses were having a hard time finding that. So wage growth in many of the businesses around here has been pretty healthy as they try to hang on to the workers they have. Now once oil prices did that dramatic fall and farm incomes are now into their third year of a slump we’re starting to see job layoffs in our region. If there is any good news in that, we see some evidence that those laid off are having an easier time finding other jobs.

Q. How about the risk that things fall apart? How much danger do you see of another recession?

A. I’m mindful of how long this expansion has been. I don’t know that there’s a criteria that says it has to end, but I don’t know that we’ve conquered business cycles either. So I’m watching corporate earnings. Is that a harbinger of a slowdown coming? We’ve had two quarters of soft G.D.P. growth. We don’t have business investment that has kicked in in a way to contribute. But when I look at some of the research on predicting recessions: We have an upward-sloping yield curve. It looks like with the kinds of jobs numbers we’re seeing and housing beginning to pick up, it doesn’t feel intuitive yet that that’s what we’re facing. But I don’t predict recessions either.

Q. You voted repeatedly to curtail the Fed’s final round of bond purchases, known as QE3. Looking back, do you still regard that final push as a mistake?

A. I’m still concerned about QE3 because of how it complicates monetary policy going forward, because of the amount of accommodation it provides. I think the challenge I felt then and I think is still true today, is that when central banks are at that zero lower bound, this move into unconventional measures to try to overcome that, we don’t know how those will turn out. We don’t. And so I think time will tell. Maybe I’ll be completely wrong and these will be harmless. On the other hand, I think we cannot ignore the potential cost of those. Do three years tell me I shouldn’t have been concerned, or that those concerns were warranted? I think it’s too soon to tell.

Q. Doesn’t that suggest the Fed should be cautious in raising rates, because it may have limited means to deal with renewed economic weakness?

A. I think it’s one of the reasons to go slowly. The thing I’d be cautious of is this idea that we don’t have much room to do something at the zero lower bound and yet we can raise rates quickly. When I hear people say, ‘We can raise rates quickly,’ mechanically, that’s true. Is that desirable? I don’t think so. But I think that again argues for why we’ve agreed to a slower path in moving away from zero and trying to get somewhere else, and why I don’t want us to stop.

Q. Did the negative impact of lower oil prices surprise you?

A. I was like others. I think the idea was that you’d have this dramatic drop in gasoline prices that would be a boon to consumers and we’d see that first. I think we really underestimated how much investment had gone into the oil and gas sector. In our particular region, some of those oil companies were leveraged. And we know what happens when leverage meets with a change in the economy, and so the pain has been felt maybe even relative to other parts of the country where energy is prominent. So yeah, that’s been painful. Now I wouldn’t say the consumer hasn’t benefited. They’ve been able to save a little more and still spend. They’ve learned to be a little skeptical. I think it will continue to be a tailwind to the consumer to have these low prices, but we certainly are feeling the effects.

Q. Is the worst over?

A. I ask that question a lot in my engagement with businesses in this region. And it’s anybody’s guess. Clearly we have more supply than demand today. Some tell me by the end of 2016 we’ll see things begin to stabilize a little more. Maybe through 2017, maybe 2018. I think we’re in a lower oil price environment for a while until those dynamics get sorted out.

Q. We’ve had steady growth for several years now. Declining unemployment, low inflation. Has the Fed basically succeeded?

A. I don’t think the Fed can take credit or blame for the entire performance of the economy here. Do we have more jobs today? Of course. Is inflation low and stable? Yes, influenced by many factors. I think this phase we’re in is our real challenge which is: Can we exit a policy in a way that will allow the economy to operate stably? At the end of the day, when I look at the Federal Reserve Act, I don’t just see a dual mandate. What I see are words that say “long run”: the economy’s long-run growth potential. And that’s where our challenge always is, is thinking about decisions we’ve made today and how they’ll affect the long run. We’ve made good progress. I’m happy to take as much credit as we should, but not more. I think history will judge whether the central bank had this right.

Q. Why are so many people still so angry at the Fed?

A. When you look at some of what seems like such great injustice that came out of the 2008-09 crisis, it lingers with us today. And perceptions matter to the public’s trust and confidence. We know this from past crises. When things aren’t going well, when people feel that there hasn’t been an equitable solution that benefits them as well as others, I think you get this kind of angst.

And we should be honest: There were decisions made along the way that may have been perfectly justifiable. People had reasons to think that was the right thing to do. But when you think about what perceptions were created, I think we have to care about that and think about that. That’s the role you play when you’re in the business, like the Federal Reserve is, of relying on the public’s trust and confidence in it. It’s not just the letter of the law, it’s thinking about things like perceptions and how will the public see what may be a well-intentioned action. I think the fact that the economy lost 10 million jobs, people don’t forget that easily. When they look to say, “Am I back to where I was before?” I think they probably still have questions. Should it all be aimed at the Fed? No. Have we played a very prominent role? Yeah. So understandable to some extent.

Q. I’m struck that you and your colleagues appear to be in broad agreement about the proper course of monetary policy. No one is talking about doing more; no one is talking about rapid retreat. Is the internal debate too narrow?

A. I don’t think so. I make sure that I am talking to a broad cross-section in my region. I will hear everything from “Keep those rates at zero” to “You are way past the time of being somewhere more normal.” I think the views are heard. They do influence my perspectives, they make me question the data — and they make me question, If I have group of economists all moving in the same way, is that right? How much are our models herding us toward this answer? That is the job of the policy maker to always be challenging your own biases and leanings on these issues. And I listen carefully. I think you’re obligated to do that and then you’re obligated to say this is how I see it when it comes to a policy decision.

Q. Against this wisdom-of-the-crowd model, some critics argue the Fed should adopt a policy rule, limiting the role of human judgment.

A. We look at a range of policy rules and I look at them carefully. They are simple, imperfect ways to model the economy and say: “Where are we relative to growth, employment, and all of those things? Where would we pin a policy decision?” They certainly are informative. Is one of them the answer? I doubt it. We could pick any of them and it would be imperfect. There is always going to be judgment. Where I think we don’t need to keep resisting is to say: What is it we could offer that might better explain how we arrive at these decisions? Maybe we’re not hitting the mark yet in terms of describing to Congress and the public what is guiding our decisions. I would be very open to that.

We want to acknowledge our accountability, and I think we want to preserve our independence. I don’t want bodies that are charged with spending our taxpayer money to also be involved in this decision [about making monetary policy] and so I think it’s incumbent on us to say we’ll do whatever we can to try to describe this — short of handing over those reins.

Q. Explain to the public why the presidents of regional reserve banks, who are not nominated by the president or approved by Congress, should play a role in determining the course of monetary policy.

A. I think the issues that caused the institution to be structured in the way it is are no different than 100 years ago. This is an institution that makes decisions of consequence to the broad public, and its connections to an economy the size of the U.S. I think have to come from the grass-roots level. I think a central bank, just like a currency, relies on the public’s trust.

Concentrating decision-making in a smaller group has never been in this country the path to public trust and people feeling like institutions are working for them.

Q. We’re approaching the eighth anniversary of the financial crisis. Is the government ready to deal with the failure of a large financial institution?

A. One thing that I’m still watching for, the Dodd-Frank Act said we’d have credible resolution plans in place that would tell us that there was a way forward if one failed. Unless I’ve missed it, I haven’t seen that those plans have been deemed credible. So I‘m very much looking forward to seeing the Fed and the F.D.I.C .tell the public that we now have plans in place. That’s an essential step, to know that at least those that will be involved in that resolution process have seen plans that look like they’re workable. We haven’t seen those. I know people have been working on them — lots of paper has been moving around to try to get to that point — but it’s 2016. I don’t know how long it takes, but I think it would be reassuring to the public to know that there are ways to liquidate or resolve these institutions in an orderly fashion.

Q. Do you think there are ways to do that?

A. It’s hard to imagine. But, again, if you think about how these living wills were designed under Title I, if that can’t be demonstrated, then the banking regulators have remedies to say, “Let’s get them where they could be.” So in theory we ought to be able to get there with that, combined with creating higher levels of capital that should serve as a buffer in a crisis. I’m not being critical. I know people are working on it. But those two things, they have to be able to say to the public we’ve realized the objectives of this reform. And I’m still watching. And I wish them all the best.

Q. Mohamed El-Erian suggested in his recent book that the Fed and other central banks have basically created a situation they can’t unwind. He argues that they need fiscal authorities to encourage faster growth.

A. I don’t think the answer to our economy’s issues will be solved by the government. I think the key to economic prosperity in this country is where we’ve let markets operate, with some overlay of regulation. Thinking that it’s either the Fed or the federal government that will fix this economy is probably overselling that. Have their been opportunities? Yes. Had we worked more in concert, might we have gotten a different outcome? Perhaps. But at the end of the day we should not overcompensate for what we see fiscal authorities doing, nor do I think they can step in and provide all the answers. As we begin to adjust policy in line with where this economy is growing, that gives us the best chance of letting the market price where it should be making investments and thinking about how to allocate capital.

The Fed can’t be counterstructural. We can be countercyclical in trying to push against an economic downturn, but there are many other aspects of our economy.

Q. But have you created distortions you can’t unwind?

A. I hope he’s wrong.

Q. We all hope he’s wrong.

A. I think you have to be honest and say that there are no free lunches here. When monetary policy responds, it’s a sort of a bridge to stronger growth. I’ve been concerned about that because at some point you do have to unwind and you want that unwind to happen in the least disruptive way possible. But of course as you move away there will be reactions.

I’ll give you an example. We’re now in our third year of farm incomes coming off dramatically from their highs, 50 percent drops. Land values have come off a little bit, but they’re holding up pretty well, and again I think that’s low interest rates. When you look at what drives farm value, it’s income and interest rates. Will they continue to hold up as we continue to move along here? I suspect there will be some adjustment. There will be. I would like that to be as smooth and uneventful as possible, but given all we’ve done, I expect it could be bumpy as we move through this. And that will be the challenge for my colleagues and I.

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