Less than three weeks after the Federal Reserve Board voted to decrease the Fed Funds rate by 50 basis points — the first rate drop in a year when roughly seven had been predicted, and the first lowering since 2022 — Neel Kashkari, president of the Federal Reserve Bank of Minneapolis and a voting member of the Federal Open Market Committee, shared insights into FOMC decision-making at the Bank Holding Company Association’s Fall Seminar Oct. 7 in Edina, Minn. In addition to his thoughts on monetary policy, Kashkari commented on a range of topics of interest to bankers and to session moderator, John F. Healey, president of Crown Bankshares, Edina, and BHCA president.
Calling the post-covid years “incredibly difficult to forecast,” Kashkari said the Fed was surprised at how stubborn inflation had become. “You might recall, we called it ‘transitory,’” Kashkari admitted.
Inflation responded to Fed rate intervention until it didn’t, and prices remained stubbornly high. “Traditionally, when the Fed raises interest rates aggressively to bring inflation down, it can lead to a recession,” he said. “So far, that has not happened, and the labor market has been very resilient.”
Kashkari said the economy was robust and said he supported lowering because of worries over the jobs market. “Historically, when the labor market weakens a little bit, it tends to weaken by a lot. And we don’t want the labor market to weaken by a lot,” he said.
“I describe it this way: The balance of risks have shifted away from high inflation towards maybe higher unemployment. And that’s why I thought dialing that policy was the right move,” Kaskari added. “I could have supported 25 or 50 basis points. At the end of the day, the judgment was that 50 basis points was the right move.”
Of the 12 FOMC members voting, only Gov. Michelle Bowman dissented, preferring a 25 basis point reduction. Addressing Bowman’s dovish stance and likely changes to the Committee in the future, Kashkari reassured: “Everybody comes into the meeting having done their work, studied all of the data. We get about 100 pages of analysis before every meeting that we pore over. The discussions are serious, people are challenging each other’s ideas, and then people are making the best recommendation they can for what they judge is right for the U.S. economy.”
The Committee’s composition may change, Kashkari said, but “I don’t think the quality of the dialogue and the seriousness people bring changes at all.” He cited his own shift from being dovish prior to the pandemic to being more hawkish now.
With inflation moderating and a recent jobs report that exceeded most peoples’ expectations, Kashkari said housing was the only blemish on an otherwise rosy economic picture. Even with housing, though, Kashkari expressed optimism, pointing to a significant drop in rental inflation, which he said takes 12 to 24 months to roll in housing inflation. “So we think we have a lot of confidence that inflation should be on its way back down to our 2 percent target,” he said.
Housing inflation is fed by the fact that there hasn’t been enough housing stock built in the past 15 years to meet the demands of an increasing population, the supply chain problems during the pandemic, and peoples’ changing preferences on where to live, which was driven by the pandemic.
In a room filled with commercial bankers, Kashkari was asked to weigh in on commercial real estate as a burgeoning problem for lenders. “Obviously the office sector is the one that I think most people are paying closest attention to,” he said. “It’s under the most stress in urban centers all around the country … and I think the shoes to drop from that have not yet fully dropped.”
Kashkari said regulators are still determining which banks have the greatest exposure, and which concentrations are particularly worrying. “We’re looking very carefully. We’re not seeing any evidence of a systemic risk. But could there be individual institutions that face big exposures? I think the answer has to be ‘yes’.”
On the topic of cryptocurrencies and a proposed Central Bank Digital Currency, Kashkari said he cannot see a use case for any digital currency that exists outside of the existing and legal banking channels. “The advocates speculate that maybe it would be better for financial inclusion or maybe it would reduce the cost of, for example, cross-border remittances. I haven’t seen any evidence that it does either of those things.”
Returning to the subject of interest rates, Kashkari said there’s a question mark in his mind about how low rates ultimately will go. “Before the pandemic, I thought a neutral Federal Funds rate was around 2 percent … I think it’s gone up … closer to 3 percent,” Kashkari said. “The longer the economy keeps exceeding expectations with what seems like a tight interest rate policy and the job market stays strong, which is great, and consumption stays strong, and GDP stays strong, the more I think maybe we’re not that tight and maybe therefore we’re not gonna go down as far.”