The former vice-chair of the US Federal Reserve Board, Donald Kohn, talks to Silvia Pavoni about why he is concerned over the lack of tools available to tackle another serious global economic problem.

Q: As the global economy slows down, and low or negative interest rates reduce central banks’ armoury, what tools should they use? 

A: You have got a serious question here. The US has been less affected: growth is slowing here but [follows a] trend; the labour market still looks pretty good. And the Federal Reserve has room to lower rates if it wants to do that. Elsewhere around the world, it is not so [positive]. You are seeing that reflected in a kind of [general] pessimism. You can see this in yield curves, you can see this in returns on treasury securities, gilts, bunds, negative rates in Europe. People are very worried and I think part of the worry is that monetary authorities do not have as much ammunition as they used to – they are not even close.

Unconventional tools are being used in a number of places and are available for use in the US. In my view, they have been effective: the forward guidance about where interest rates might be expected to go gets built into intermediate and long-term rates and that reduces the cost of capital, raises asset prices and so on. And there’s no obvious upward limit on something such as quantitative easing, but you’ve already got interest rates expected to be zero for a very long time.

If you had a serious problem in the global economy or in the US economy, the tools are limited. So [as warned during the October 2019] International Monetary Fund and World Bank meetings, there is going to be more pressure on fiscal policy if there is a serious downturn, because monetary policies are running out of room.

Q: What is the impact of the current environment on financial stability?

A: When treasury rates and the policy rate are very low, [investors are] going to look around for yield. And you can see that – in flows into emerging market economies, for example, and into businesses. In the US [there is a] very large build up of corporate debt facilitated by increasingly easy credit. So I do worry about this. I think monetary policy is a very poor instrument to deal with financial stability issues.

We do need to think much harder about tools that regulators might have, to target particular pockets of risk that are building up in the economy or in the financial markets. The Fed has some regulatory authority, but it has to share it with other regulators in our crazy balkanised system, and there is no one really looking outside of the banking system very well.

Q: Will central banks’ unelected power continue to be questioned?

A: The Fed came under intense fire [during the financial] crisis, when I was still [there], and coming out of the crisis, people, particularly Republicans, seemed to challenge the legitimacy of what we were doing – both lending to non-banks when they were undermining financial stability and, later, quantitative easing [measures]. And I think most of the concerns that were expressed, that [our actions were] going to cause inflation that the Fed could never tighten, were just wrong and have been proven wrong. But it was part of an attack.

Now you have got the president of the US disagreeing rather vehemently with the chair of the Fed, and being open and frequent about it. What does the central bank need to do? It needs to focus on its remit, and the US Congress gave the Fed [specific] goals related to real goals: maximum employment and stable prices. And I really like how [Fed chair] Jerome Powell has been handling this. Every time he presents a policy, he relates it to those two goals and tries to explain how the policy is going to achieve them.

On the communication side, Mr Powell has done a great job with the legislature. I was really impressed when he testified in July 2019, and he [received] praise from both sides of the aisle for the job he was doing, and support for the independence of the institution. He has talked about wearing out the carpets on Capitol Hill talking to legislators, and it is paying dividends.

Donald Kohn is the former vice-chairman of the US Federal Reserve. He is currently a member of the Bank of England’s Monetary Policy Committee and a senior fellow in the economic studies programme at the Brookings Institution. He spoke to Silvia Pavoni at the FT US Banking Forum on October 24, 2019.


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