Neel Kashkari fireside chat at Torcuato di Tella University, Argentina

I thank Juan Pablo for inviting me to chair. It's too much to chair this session. So this talk will end at 7 PM sharp, okay? Because we have other activities.

Thank you. It's great to be here. I really appreciate the invitation. This is my first visit to Argentina. It's a great honor for me to be here, and thank you to so many students here tonight. What a great turnout. I really appreciate it. I'm going to speak just for a few minutes, and then we're going to have a discussion, and then I hope we're going to have questions from all of you. One thing I just want you to know is I think we're live streaming this to the public in the spirit of transparency. I like to live stream my big speeches and talks such as this. So when we get to Q&A, I think there is going to be a microphone somewhere. Yes, please speak into the microphone just so that people online can hear you ask your question. So the Minneapolis Fed, I have some slides that I can run through fairly quickly. The Minneapolis Fed is one of 12 Federal Reserve Banks in the United States. In American history, there were a few attempts to establish a central bank in the US. They each lasted about 20 years, and then the government got rid of them. Then in the late 1800s, the US economy was hit by a lot of financial crises and panics and depressions. Then there was a really big one, the Panic of 1907, and finally the US government said, 'Hey, we need to have a central bank to try to manage through these crises.' So then they passed the Federal Reserve Act. They created the Federal Reserve System in 1913. What they did was a little bit unique. They didn't want all of the central banks to simply be housed in the nation's capital. They wanted to spread it out around the country. So they created something called the Board of Governors, which is in Washington DC, and then they created 12 different independent Federal Reserve Banks spread out around the country, where we're supposed to be representing our regions in the monetary policy process. I'll show you this quick chart. Historical background: US Constitution ratified in 1788. President Lincoln created the first national currency in 1861. Banking panics hit; we didn't have a central bank yet. Federal Reserve created in 1913. But then it wasn't until 1979 that the modern way the Federal Reserve operates as an independent monetary policy was established. My point of showing this history is sometimes these things take a long time to work out. You start something, it doesn't work quite right, you take a step back, and then crisis hits, and then you start something again. So it took a long time for the US to get to where it is in our type of modern monetary policy that we have today. This is just a chart of the United States. The different colors show the different regions. The part that I represent is the Minneapolis Fed up at the top in yellow. Our jobs, my colleagues are here, Wampa, we're very blessed as part of our research department. He's also your professor. We're happy to share him with you, but we want him to come back to Minneapolis. And Andrea Raffo is our research director. What they helped me do is both understand what's happening in our regional economy, what's happening in the national economy, and what's happening in the global economy as we decide what monetary policy to set for the United States. So at the Federal Reserve, we have two goals that the US Congress has assigned us. One is stable prices, that we've defined as 2% inflation. And one is maximum employment, as many people as possible employed, contributing to our economy, who want to be employed. And then of course, monetary independence, as I talked about, is really critical to us ultimately being successful. Now if you look at the history here, in the 1960s, that's the left-hand side of the chart. The red line is inflation. The US enjoyed a period of pretty low unemployment and low inflation in the 1960s. And then in the 1970s, there were a bunch of oil shocks coming out of the Middle East, and oil prices skyrocketed all around the world, and that led to very high unemployment and very high inflation at the same time, what we call stagflation. But in response to that, the Federal Reserve did not raise rates as aggressively as it should have, under political pressure from leaders in Washington who said, 'No, the economy is suffering enough. Don't do any more with monetary policy.' That was a mistake. It led to what we call the unanchoring of inflation expectations, where people started to be convinced that we have high inflation now, we're going to have high inflation next year, we're going to have high inflation the year after that. And if people embed that belief in their thinking, it becomes a self-fulfilling prophecy. Because if you have a job and you think that prices are going to keep going up, you're going to go to your employer and say, 'I need a raise just to keep up with high prices next year.' And then your employer is going to say, 'Okay, fine, I want to keep you as an employee, so I'm going to pay you more, but now I'm going to charge our customers more to pay for this.' And it ends up being a vicious spiral that just continues and continues. So that started to happen in the 1970s in the US. Then a new Federal Reserve chairman, Paul Volcker, was appointed in 1979, and he said, 'No, the Federal Reserve needs to act aggressively to break this cycle of inflation.' And he raised rates aggressively, causing a very deep recession. Unemployment went up, but that pain was necessary to bring inflation down. So if we look ahead, you can see here on the left-hand side, the bluish-green line is our policy rate. It went up very high, leading to a big recession, that's the shaded area. But on the right, you can see that unemployment then fell and inflation fell. His monetary policy was ultimately effective in breaking that vicious cycle of high inflation. So if we look ahead up until the pandemic, following that painful episode, the US enjoyed a very good economy. You can see here, inflation basically trends down at around a 2% level. It trends down to 2% in the 1990s, stays there. In the mid-2000s, you have the financial crisis of '08. It stays at low inflation. So basically, the monetary policy independence was foundational and set up 30 or 40 years of a good economy that followed it. But it was a tough transition. Once adopted, it was a very powerful benefit for the country. Then of course, what ended up happening: COVID hit, the economy was shut down. The Federal Reserve and the government did a lot to support the economy. But then of course, as COVID ended, we were surprised by very high inflation. So what ended up causing the high inflation? Supply chains around the world that were messed up. So if you bought some good, maybe it's a washing machine that was made abroad, if the supply chains for that washing machine, if the parts were not available, then you couldn't buy it in Argentina and we couldn't buy it in the United States. It was a global supply shock. There's also disproportionate demand for goods. Every year, every day, consumers will spend so much on services and so much on goods. Well, when the services sector shut because of COVID, you weren't going to restaurants, you weren't getting on airplanes, you weren't going to the barber shop. People stayed home and then they just spent money on goods. So the goods sector was overwhelmed at the same time that the goods sector was facing those supply disruptions. So that was very inflationary. We also had workers who left the labor market and were afraid to come back in because of COVID. We had a lot of stimulus. And then finally, we had the major shock of Russia invading Ukraine, which sent oil prices and commodity prices through the roof, not just for Europe, all around the world. These are global markets, and we all experienced high inflation from that. So if you look here, in response, if you look on the right-hand side, the blue line is what the policy rate is. In the face of high inflation, we raised our policy rate very, very aggressively to try to bring inflation down. And you can see the red line on the left, inflation then fell quite quickly. But the pleasant surprise is unemployment has stayed low. Historically, when the Federal Reserve has raised rates aggressively, it has typically led to a recession and led to a big increase in unemployment. That didn't happen this time. Why didn't that happen? I think that didn't happen because most of the reduction in inflation actually didn't come because of our policy rate. It came because those supply disruptions got better. Supply chains got fixed. You could buy the goods that you wanted. The services economy reopened, so people could balance out their spending again. The COVID waves ended, it went back in the background. Workers came back into the workforce. And the war in Russia-Ukraine hasn't amplified; the commodity markets have really settled down. So a lot of the supply factors got better. And so the federal funds rate, our policy rate, it was important, but I would say it was not the most important factor in bringing that inflation down. And then the last thing I'm going to say, I guess I have two more charts. A word on inflation expectations. You're going to hear monetary policymakers and monetary economists talk a lot about this, how important it is. The red line is what the actual inflation in the United States that I showed you a moment ago. The blue line is a market measure of long-run inflation expectations. So what do financial market participants think inflation is going to be between five years from now and 10 years from now? And what's remarkable, it barely moved. So this huge episode of high inflation, and American investors and investors around the world who invest in American securities said, 'We trust that the Federal Reserve is going to keep inflation in check.' And that trust ultimately comes from the political support that the Federal Reserve enjoys from both of our major political parties, who have said, I mean it's not unanimous support, but there's a lot of support amongst a lot of the leaders who said we need to keep monetary policy independent so that we can bring inflation down, keep it down, and not have politics be involved in that. And this is the best chart I can think of that demonstrates what that independence and what that credibility looks like. So final thing, some key lessons that might be relevant here. Low and stable inflation is a precondition for economic prosperity. You've got to conquer inflation and you have to keep it conquered. Now, achieving low inflation might require short-term economic pain. It did in the US. I know you're going through a profound fiscal adjustment right now. And finally, long-term, whatever structures you design and put in place, it's easy for me to say this, I know it's hard to do in practice, to the extent possible, these institutional structures should be designed to endure over many economic cycles and over many political cycles. So one of the things that happened, and I'm going to end now, is when President Carter, a Democrat, appointed Paul Volcker to be chair, President Carter was then defeated in his re-election by President Reagan, a Republican. President Reagan reappointed Volcker, and that started a pattern that's been followed many times by the Federal Reserve chair being reappointed by a future president who might be of a different political party. And that has been a nice demonstration of political support for having an independent central bank and independent monetary policy. Anyway, I hope that overview was helpful just to get us started. I'm excited about the discussion.

The '08 crisis, I was at Treasury 15 years ago. It felt like we were in economic war. I mean, nobody was shooting at us, thankfully, but every day the question was, can we get the economy through one more day? Is there going to be widespread banking failure across the US economy? And ultimately, all the elements of government worked together. I was at Treasury, which is the finance ministry effectively, and we worked very closely with the Federal Reserve, the central bank, and with the Congress ultimately in giving us authority to inject capital into the banking system to stabilize the financial system. In '08, the US financial system, in my opinion, was effectively insolvent, which meant the losses that they bore from the mortgages that they had exceeded their capital. It didn't mean that every bank was insolvent, but on the whole, they were insolvent. And so what do you do in that moment? The only balance sheet strong enough to bear those losses is the taxpayer, is the government balance sheet. So all of our operations were complicated, but it was a way of taking the risk out of the private sector and putting it on the balance sheet of the federal government because only the federal government was strong enough to withstand it. Now, could it happen again? After '08, the Congress passed some financial reforms, notably one called the Dodd-Frank Act, that raised capital requirements, did a bunch of stuff, but it raised capital requirements on the biggest banks. So the biggest banks today have a lot more capital than they had before the financial crisis. My humble opinion is it didn't go far enough, but I will tell you, I'm of a minority view in that, and there does not appear to be any political appetite in the United States to raise capital requirements further. There's a proposal that's been floated at the Federal Reserve and some other regulators to raise capital requirements. There was a lot of pushback publicly from many different constituents, and so now they're coming out with a more modest proposal. And so, you know, I hope we can continue to take this forward because I worry that another '08 crisis could always happen. We do know a few things. One of the sources of the US crisis was that many, many people were able to get loans to buy a house with no money down, no documentation of income. You would just write, 'Well, I could make up a salary,' and you could get a loan. That has largely stopped. So they have clamped down on some of those egregious lending practices. But there's still, you know, risks are always out there. One thing that I'm a little bit optimistic about, you might not be sure how much of this is on your radar here, in the US there's a lot of focus on the private credit arena, where instead of banks making loans, it's private equity companies and other types of off-balance-sheet vehicles that are making loans to businesses. And it's scary on some level because it's exploded to a trillion-dollar-plus market fairly quickly. But as I've examined it, you know, a bank in the US today, a big bank, is levered roughly 10 to one, 10 times as much assets for their equity. These private credit vehicles are typically levered one to one, so it's much less leverage. Banks have overnight liquidity, meaning you can go tomorrow and withdraw your money from the bank. These private credit vehicles generally have long-term liquidity. So on both fundamental dimensions, where do systemic risks come from? The intersection between leverage and maturity transformation. So on both those dimensions, these private credit vehicles look like they're much lower risk than banks. So while I wish we had tighter regulation on the banks, I'm actually cautiously optimistic that some of these market developments might actually lead to less risk, at least less systemic risk, in the financial system.

Well, we've made a lot of progress in bringing inflation down. Okay, so 2% is our inflation target. Depending on your measure of inflation, it went up to 7, 8, 9%, and it is now running, I would call it, at around, by our primary measure, it's now running at around a two and a half percent run rate, and a lot of evidence suggesting that it's going to continue to fall from here. So we've made a lot of progress in bringing inflation down. And while the labor market has remained tight, it's not as tight as it was a year ago, so we've seen some evidence of labor weakening. And so if we could freeze things roughly where we are, we would say this is great. Inflation's almost back to target, labor market is strong. What we want to avoid is inflation keeps going and then the unemployment rate takes off from here. Like, it's not worth it at this point to have the unemployment rate shoot up from here. So we cut interest rates by half a percentage point, and we said we're going to monitor the data in terms of where we go from here. But even today, I think that after cutting rates 50 basis points, I think we are likely still in somewhat of a contractionary monetary policy stance. So it's not as though we've taken our feet completely off the brakes. We've just relaxed the brakes a little bit, and we'll see how we go.

Yeah, we, um, I'll even generalize it a little more. We look at whether it's trade policies or fiscal policies that are passed by the Congress and the president signs into law, whatever they are, tax increase, tax cut, spending increase, tariffs, all of those are inputs into our models as we analyze the US economy. We want to analyze what we think potential growth is for the US economy, potential output, where we are relative to that potential, and is inflation going to go up or is inflation going to go down, is unemployment going to go up or going to go down. But trying to guess what an administration is going to do or what Congress is going to do, I don't think we're better at that than anybody else. And so we pay very close attention. Once they enact something, then we'll put that in our models and say, okay, this is what we think it means for monetary policy. But we don't try to forecast what they're going to do.

Wait. Yes, here. Yes. And by the way, I want to encourage the students to ask questions. Let me say, I give a lot of talks at universities in the United States. So what are the two types of questions I most often get? One is career questions, like 'You started out as an engineer, how'd you end up doing this?' which is fair. And the second is about Bitcoin. And so, you know, I just want to say anything is fair game.

Yeah, we pay attention very closely to economies all around the world because, you know, the US is a very big economy, but what happens in the world affects us too. So definitely care, and we pay a lot of attention to it. It's hard for me to read. China seems to me to have managed to delay the reckoning of their housing bubble for a surprisingly long time, and maybe they're going to be able to keep doing that. I just don't know. I think long-term, how long the housing adjustment takes in China, I don't know. My guess is they can probably muddle their way through for a long time. Structurally, I think their economy is not remotely competitive with advanced economies around the world. You know, on one hand, China says that they want to be an innovation economy and compete with the best around the world. On the other hand, they're literally clamping down on their innovation sectors for their political ends. So from my perspective, they're shooting themselves in the foot if they want to actually be competitive globally, whether it's in AI or in any other innovation you want to think of. And so I don't know. I'm not worried about China as a competitor to the US. But obviously, China's economy is major, and if they go through some downturn, one risk is spillovers to the rest of the world. So what would the mechanism be? The mechanism would be fear. I mean, that's the first mechanism. If you see a major economy going through a brutal adjustment, that can upend markets all around the world, and then that gets transmitted everywhere, just like Russia invading Ukraine set a spike, a shock all the way around the world. So that's one issue. And then the second issue that I don't know enough about is, could that lead to some geopolitical risk? You know, an economic risk leads to some geopolitical risk, and I don't even know how to think about that.

Well, long run, the US has a clear challenge here. So talk about things that we could, how we could screw it up. There's something called the Congressional Budget Office in the US, which is a nonpartisan group of economists who work for the US Congress, and they forecast out the debt. And if you look at the forecast of the debt, it just skyrockets over the next 30 years, mostly driven by demographics. Our society's aging. Many of our entitlement programs are paid for by current workers paying for current retirees. As that ratio gets imbalanced, the debt just goes to the roof. That is clearly not sustainable, and so something has to be done. And that's going to be our politicians are going to have to decide some combination of raising taxes, cutting benefits, raising the retirement age. There are a few policy levers you can play to balance that out. I don't know what they're going to choose to do, but something has to be done. So on one hand, yes, I'm concerned that if they do nothing, this is unsustainable, and that would probably lead to much higher interest rates well into the future. In the near term, I'm not particularly concerned because there's ultimately fundamental confidence in the US economy, in our near-term outlook, in our medium-term outlook. US government debt, obviously countries have gotten into trouble with less debt to GDP than the US has now. At the same time, you've got Japan as an outlier, which has twice as much debt to GDP and has low interest rates and no trouble financing themselves. And so is the US more like a country that got into trouble or more like Japan? I don't know what we are. I know this can't go on forever, and the challenge is how do you motivate political support to make the tough choices before it ends up being a problem.

I haven't seen any evidence of that. You know, when we raised the policy rate five and a half points, 550 basis points, we did what we needed to do, what we thought was the right thing to do, and there was a lot of political support to let us use our best judgment. So I'm hopeful that there won't be.