Early last October, Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, spoke to several dozen graduate students at the University of Minnesota. Federal Reserve officials tend to choose their words with exquisite care. One misstatement or clumsy phrase, even before an audience dressed in shorts and flip-flops, can spook the financial markets. With the Fed, the nation’s central bank, rapidly raising interest rates to combat the highest inflation that the United States had experienced in four decades, Wall Street was especially skittish. But there was little chance of Kashkari’s committing a gaffe: He was a skilled public speaker, an ability that he honed during a failed campaign for governor in California in 2014. He also had a politician’s knack for using easy-to-understand anecdotes to illustrate complicated ideas.
Kashkari was wearing an N95 mask as he walked into the auditorium that evening; his wife and one of his children had Covid-19, and though he tested negative earlier in the day, he wanted to be cautious around others. The mask, which he removed when he took his seat at the front of the room, was a reminder that the pandemic was still disrupting workplaces and daily life. Kashkari, who is 49, carried with him a bottle of Cherry Coke Zero. He drinks soda throughout the day and seldom goes anywhere without a bottle in hand. But the Cherry Coke Zero was also a way into the story that he wanted to share — about inflation, which began spiking in the first quarter of 2021 and was running at around 8 percent year-over-year.
Kashkari told the audience that he often stocked up on soda at a service station near his daughter’s school. The store had recently installed Cooler Screens, digital displays that, among other things, showed which drinks were available and what they cost. Curious, Kashkari asked about the screens. The store’s manager told him that they were installed to make it easier to update prices; instead of doing it manually, employees could now do it with a push of a button. Those Cooler Screens, Kashkari said, were a window into the current economy: Prices were rising quickly and unpredictably, and merchants, stretched for workers because of a very tight labor market, were having to adjust how they operated in order to keep pace, a sign that inflation was possibly becoming more deeply rooted. “That was a punch in the gut at 8 in the morning,” Kashkari said, drawing laughter from the students.
Zooming out, Kashkari explained that the Fed had initially thought that the rise in inflation would be temporary. And it was conceivable that inflation might have eased on its own: Covid had disrupted global supply chains and had also created excess consumer demand, and perhaps, over time, things would have come back into balance on their own. But unchecked inflation can be ruinous, and Kashkari said that for the Fed, the question became, “How much are we willing to roll the dice?” The central bank was now aggressively increasing interest rates to bring inflation back to around 2 percent, its long-established target. If the Fed failed to get inflation lower, it would damage its credibility and sow doubts about its ability to guide the economy. “We at least need to walk the walk,” Kashkari said.
ADVERTISEMENT
The “we” underscored an essential point about the Fed. When the Fed is in the news — and it has been in the headlines a lot lately — the focus is inevitably on the central bank’s chair. That was the case under Alan Greenspan, Ben Bernanke and Janet Yellen, and it is also true under the Fed’s current chair, Jerome Powell. The effort to rein in inflation is seen as a test of his leadership and a battle that will go a long way to determining his legacy. Monetary policy, though, is made by a committee that includes the Fed’s chair, the six other members of its board of governors and the presidents of the 12 regional banks that are part of the Federal Reserve System. Kashkari, now in his eighth year at the Minneapolis Fed, has assumed an unusually high profile for a regional Fed president, and he brings an interesting résumé to the fight against inflation.
If Kashkari’s name sounds vaguely familiar, it should: As a Treasury Department official during the 2007-9 global financial crisis, he administered the Troubled Asset Relief Program, or TARP, through which the government propped up banks and other institutions to prevent them from going under. The $700 billion bailout was deeply controversial, and much of the ire was directed at Kashkari, who had previously worked for Goldman Sachs. An ex-banker throwing a lifeline to bankers was a bad look, to put it gently, and Kashkari was pilloried in the press and on Capitol Hill.
- Dig deeper into the moment.
As Kashkari tells it, the financial meltdown shook his faith in the self-correcting powers of capitalism and also prompted him to reflect more deeply on the inequities of the American economy. He arrived in Minneapolis as a chastened free-marketer who thought the Fed could play a bigger role in pushing for a more just economy. To that end, he helped put the Minneapolis Fed at the center of discussions about the economic consequences of racism and other social ills. He also staked out a position as an ardent dove. In Fed-speak, doves prefer looser monetary policy to maximize employment (lower interest rates stimulate growth, which leads to more hiring) while hawks favor tighter credit to keep inflation down.
When it became evident to him in late 2021 that inflationary pressures were not abating, Kashkari changed course and joined the hawks. Several other Fed officials did likewise (“There are no doves in foxholes” is a quip I heard a few times in recent months, and apparently what passes for central-bank humor). Kashkari embraced his newfound hawkishness with the zeal of a convert, becoming stridently hard-line in his public comments. His about-face has surprised former admirers who were encouraged by his effort to get the Fed to embrace a broader conception of its own mandate and who worry that the central bank has raised rates too abruptly. Kashkari insists that he hasn’t wavered in his desire to promote a fairer economy but that taming inflation must be the priority. “The sooner we take the medicine,” he says, “the less painful it will be.”
The medicine appears to be working — inflation is moderating, and some economists think that we have seen the worst of it. Wage growth remains strong, though, and until that changes, it is going to be very difficult if not impossible for the Fed to get inflation back to 2 percent. The Fed insists that its target rate is inviolable; it raised interest rates again last month and indicated that more increases are likely. There’s a good chance that the Fed could push the economy into recession. As former Treasury secretary Lawrence H. Summers put it when we spoke recently, “It’s hard to stop a car on ice without skidding.” If there is a recession, the pain will probably be felt most acutely by those on the margins — the very people that Kashkari was eager to help. In a sense, Kashkari has come to embody the harsh trade-offs at the heart of the battle against inflation.
ADVERTISEMENT
When Paul Volcker died three years ago at age 92, he was widely remembered as the savior of the American economy. The imposingly tall, cigar-chomping Volcker was the Fed’s chairman from 1979 to 1987. At the time of his appointment by President Jimmy Carter, the United States was reeling from years of high inflation, high unemployment and sluggish growth. “Stagflation” was the word coined to describe this miserable triad. Two years before Volcker was named Fed chair, Congress passed the Federal Reserve Reform Act, which decreed that the central bank had two primary tasks: keeping prices stable and promoting maximum employment — what has come to be known as the Fed’s “dual mandate.” In the late 1970s, the Fed was failing at both.
Volcker believed that curbing inflation was the necessary prerequisite for a return to economic health. Inflation is the rate at which prices increase over a given period of time. When it is persistently high — and it was around 12 percent annually when Volcker took office — it erodes the purchasing power of consumers; their money is worth less and less. Under Volcker, the Fed raised interest rates to 20 percent and tipped the economy into recession twice — once in early 1980, and again the following year (loosely defined, a recession is when the economy contracts for an extended period). But the draconian measures worked: By 1983, inflation had plummeted to around 4 percent, unemployment was coming down and the economy was recovering. In economic and financial circles, Volcker became a sainted figure, credited with laying the foundation for decades of low inflation, relatively stable growth and rising — if unevenly distributed — prosperity.
The pandemic roused inflation from its long slumber. After Covid hit, millions of Americans were stuck at home, and thanks to the booming stock market and stimulus checks sent out by the government, many of them were awash in savings. Unable to travel or dine out, people spent money on things. At the same time, the pandemic had wreaked havoc on supply lines, and many products were no longer reaching warehouses and retail shelves or were arriving in greatly reduced quantities. Too much money was chasing too few goods, and a result was an outbreak of high inflation. Russia’s invasion of Ukraine last winter pushed up food and energy prices, compounding the problem, and the Fed has been scrambling to get inflation under control ever since. (The economist Mohamed El-Erian, the president of Queens’ College, Cambridge, and a leading voice in the debate over inflation, told me that the central bank’s belated response to surging prices was “one of the biggest Fed policy mistakes ever.”)
The Fed’s main inflation-fighting tool is its ability to move interest rates. Interest rates are the cost of borrowing money. When the Fed lowers rates, it is trying to spur the economy; raising rates is meant to slow the economy. The Fed implements monetary policy through one particular interest rate, the Federal Funds Rate, which is what banks charge one another for overnight lending. Think of it as a tiller the Fed uses to help steer the economy. When the Fed Funds Rate goes up, other borrowing costs go up. The Fed has sharply increased the Fed Funds Rate in the last year, and as a consequence, rates for 30-year mortgages have more than doubled (which is one reason home sales have been declining).
Interest-rate decisions are made by the Federal Open Market Committee, or F.O.M.C., which meets in Washington eight times a year. It consists of the seven members of the Fed’s board of governors, which includes the Fed’s chair, along with the presidents of the 12 regional Fed banks. But not everyone gets a vote. When the F.O.M.C. convenes, voting is restricted to the Fed’s governors, the president of the New York Fed and four other regional Fed presidents, who have voting privileges for one year on a rotating basis. The F.O.M.C. has been likened to the College of Cardinals, in that it deliberates in secret and the outcomes are breathlessly awaited.
The last time the Fed tightened interest rates repeatedly was between 2015 and 2018. During that period, it lifted the Fed Funds Rate by 2.25 percentage points. In just the last 10 months, it has increased the Fed Funds Rate by 4.25 percentage points. Not since the early 1980s has the central bank raised interest rates so drastically, naturally inviting comparisons to the Volcker era. There are certainly similarities: Then as now, high inflation was a global phenomenon, and it was driven by a combination of government spending and supply shocks (the 1973-74 OPEC embargo and the Iranian revolution in 1979, each of which sent energy prices soaring).
ADVERTISEMENT
But there are also some crucial differences. For one thing, interest rates were much higher under Volcker. When the central bank started raising interest rates last March, the Fed Funds Rate was effectively zero. In addition, when Volcker became Fed chair, inflation was already embedded in the economy, a point underscored by a button that President Gerald Ford wore on his lapel that read “WIN,” which stood for “Whip Inflation Now.”
By contrast, the current outbreak is relatively recent, and the public — so far, at least — doesn’t seem to be treating it as permanent. That’s important, because fighting inflation is in no small part a battle against the psychology of inflation; the Fed has been raising interest rates not just to dampen price pressures but also to keep inflation expectations from becoming “unanchored” — more Fed-speak, for when people come to believe that high inflation is here to stay, which can turn into a self-fulfilling dynamic. Kashkari’s encounter with the Cooler Screens was the sort of thing that could unnerve a central banker worried about an inflationary mind-set taking root. That happened in the 1970s, and it could happen again, but we are not there yet.
Another major difference: The U.S. economy was moribund when Volcker was appointed Fed chair, but that is emphatically not the situation today. While inflation is high, other benchmarks suggest an economy in reasonably good shape. As of December, unemployment was 3.7 percent, a near-record low. Despite inflation, planes and restaurants and stores have been full. The economy shrank in the first two quarters of 2022, which by some definitions meant that the United States was in a recession. Yet, the economy was also adding jobs during this period. A contracting economy is supposed to shed jobs, not gain them. So was that a recession? It didn’t feel like one. In the third quarter, the economy started growing again — gross domestic product, or G.D.P., was up 3.2 percent — even though the Fed had, by that point, raised interest rates multiple times. The pandemic has been a disorienting experience, and it has yielded a peculiar post-pandemic economy. “This is the most confusing economy I’ve seen in my lifetime,” says the Harvard economist Jason Furman, who served as chairman of the Council of Economic Advisers under President Barack Obama.
‘The sooner we take the medicine,’ Kashkari says, ‘the less painful it will be.’
The Fed has acted with notable certitude in the face of all this murkiness. In one of several conversations that we had in recent months, Kashkari agreed that it was difficult to make sense of the economy: “I’ve never seen the signals so mixed.” He went on to say, however, that the inflation data was unambiguous and that the Fed, having learned from Volcker’s example, had moved with appropriate haste and firepower. “We know how to deal with high inflation,” he said. But it can take a while for rate hikes to filter through the economy, and no one has any idea yet if the Fed has done too much, too little or just enough. The answer will have enormous implications not just for the economy, but perhaps also for President Joe Biden’s re-election prospects should he decide to run again.
In 2006, Henry Paulson, the chairman and chief executive of Goldman Sachs, was appointed U.S. Treasury secretary by President George W. Bush. At the time, Kashkari was an investment banker for Goldman in San Francisco. He joined the firm four years earlier, after earning an M.B.A. from the University of Pennsylvania’s Wharton School of Business (he also held undergraduate and master’s degrees in mechanical engineering from the University of Illinois and previously worked on the James Webb Space Telescope). When Paulson was named Treasury secretary, Kashkari left him a phone message expressing a desire to join his team in Washington. After first working on issues involving alternative energy, Kashkari was asked by Paulson to look at the housing market, which following a long run-up was suddenly tanking. The housing collapse triggered a financial crisis that took down two investment banks, Bear Stearns and Lehman Brothers.
When Lehman fell, Kashkari recalls, it was a “break-the-glass moment.” The Treasury Department, working with the Federal Reserve, came up with a $700 billion rescue package, and Kashkari was put in charge of it. He was a controversial choice: He was just 35, which seemed insultingly young, and a Goldman alum, no less. The press dubbed him “the $700 Billion Man” and “Ferrari Kashkari.”
ADVERTISEMENT
It can be argued that TARP worked, or at least didn’t fail: The financial system recovered, the program ended up costing less than initially projected and, as Kashkari likes to point out, the government ended up making a profit on the bailout of the banks. But it was wildly unpopular: While millions of Americans lost their homes and savings, the Wall Streeters who crashed the economy were rescued from their own greed and folly. Even though he became an object of scorn, Kashkari says he understands the rage that people felt: The bailout was antithetical to the spirit of capitalism, and as he puts it, “When you violate the core beliefs of a society, I think it leads to great anger.” The anger was exacerbated when none of the major culprits faced any legal reckoning. Kashkari says that TARP was necessary to save the economy but helped fuel the populist backlash that has destabilized our politics.
The 2007-9 crisis also prompted a change in how he thought about the world. Growing up in Akron, Ohio, he was the Alex Keaton of his household: While the rest of the family was politically liberal, he was a Ronald Reagan fanboy, drawn to the rugged individualism that Reagan championed. When Kashkari arrived in Washington years later, he was something of a free-market purist. The financial upheaval shattered his belief in unfettered capitalism. He now realized that “capitalism can get things, big things, really wrong” and that “it was important to have robust regulations to protect against the gravest risks.”
After leaving the Treasury Department in May 2009, Kashkari retreated to the Sierra Nevada, where he lived in a cabin, chopped down trees and helped Paulson write his memoirs. After his sojourn in the woods, he took a job with Pimco, a bond-trading firm in Newport Beach, Calif. But it was a restive period for Kashkari; the work didn’t enthrall him, and he was going through a divorce (he has since remarried and is the father of two young children). He eventually decided that, despite all the criticism and ridicule he faced because of TARP, he wanted to return to public service. In 2014, he won the Republican nomination for governor of California and faced the incumbent, Jerry Brown, in the general election. Kashkari ran a spirited, quixotic campaign — he spent a week living as a homeless person in Fresno — but was trounced by Brown, who won with 60 percent of the vote.
The following year, he was approached by an executive search firm that was helping the Federal Reserve Bank of Minneapolis find a new president. The Minneapolis Fed is part of a network of regional banks that make up the Federal Reserve System, which was created in 1913 and which is almost as complicated as the economy it helps manage. The Fed’s seven governors are based in Washington and are federal employees. All of them are nominated by the president and subject to Senate confirmation. The regional Fed banks are quasi-public — they were established by Congress but operate as private corporations and are owned collectively by banks in the areas they serve. Though the regional Feds all have boards that choose their presidents, every regional Fed president must be approved by the Fed’s governors. They then serve five-year terms.
Kashkari might have seemed an unlikely candidate to lead the Minneapolis Fed. He had no connection to the district that it represents, which includes Minnesota, Montana, the Dakotas, parts of Wisconsin and Michigan’s Upper Peninsula. In addition, he was not an economist; Fed officials are not required to be economists, but his five most recent predecessors at the Minneapolis Fed were. (Jerome Powell is not an economist, either, but he was a Fed governor for nearly six years before being promoted to chairman in 2018.) Kashkari’s run for governor figured to be another strike against him. The Fed zealously guards its independence from the elected branches and is sensitive to anything that suggests politicization. Kashkari feared that his foray into electoral politics would be a deal-breaker.
That turned out not to be the case: The Minneapolis Fed was looking for someone with policymaking and management experience, as well as a dash of charisma, and Kashkari was hired. He insists that he didn’t view the job as a chance for redemption, or as an opportunity to rehabilitate his image. But in the years since the financial crisis, he had grown increasingly troubled by issues like the racial wealth gap, and he believed that the Federal Reserve was uniquely positioned to shine a spotlight on them. It had not been overrun by partisanship and could objectively examine economic disparities in a way that Congress, say, could not. And Kashkari wanted the Minneapolis Fed to be at the forefront of this effort.
For many years, the Minneapolis Fed was a lodestar of what was known colloquially as “freshwater” economics, so named because it grew out of several universities in the Great Lakes region. In crudest terms, the freshwater camp believed that the economy could usually heal itself and that government intervention was generally unhelpful. This extended to the Fed and monetary policy: The freshwater view was that the central bank’s main job was to control inflation, and its adherents frowned on the idea of using interest rates to try to jump-start an ailing economy or — worse still — to boost employment. The global financial crisis, a cataclysmic market failure, was seen by many observers as a death blow for the freshwater school. That Kashkari, of all people, ended up at the Minneapolis Fed, of all places, was an intriguing coda to the events of 2007-9.
