Bund Summit Interview with Dr. Kohn: Transcript for Review
Dr. Guo:
Good to have you here with us this afternoon.
Dr. Kohn:
It's good to be here. Thank you for inviting me and including me in this wonderful Summit.
Dr. Guo:
How do you feel about the Summit so far? And Shanghai in general?
Dr. Kohn:
I unfortunately haven't seen much of Shanghai. I've seen some, though, and it's a very vibrant and alive city, very impressive. I think it's been 20 years since I was last here. Pudong was still there, and there were some buildings there. But it certainly built up since then. Just walking along the Bund and whatnot. It's been a great experience and a very impressive place.
And I would say the Summit is impressive, too. I like the fact that you have professors from the United States, China, Japan and other places. You have policymakers, mostly former policymakers, like myself. You have private investors, at least in the audience. So, it's a very unusual but productive mix of the type of people. You don't find this at a lot of the conferences I go to, which tend to be focused on economics and just economists talking to each other.
Dr. Guo:
You went to Jackson Hole this year, didn’t you?
Dr. Kohn:
Yes.
Dr. Guo:
So, how are people feeling about the U.S. economy right now?
Dr. Kohn:
I think they're fairly optimistic, but a little worried.
They’re optimistic about the path of inflation. Inflation has come down a lot; the labor market, which was very tight and putting upward pressure on wages and prices, is in much better balance; inflation expectations are anchored. So, I think it's very reasonable for the Federal Reserve to be fairly confident—you can never be totally confident in anything in economics—but fairly confident that inflation is on its way to 2%.
The message that Chairman Powell emphasized at Jackson Hole was, they're confident about inflation, (but) less confident about the labor market. Labor markets eased off from its very tight position. They don't think it needs to get any easier or softer to bring inflation down. So, they've turned their attention to try to prevent further softness in the labor market.
So, from being totally focused on “whatever it takes to get inflation down”, he shifted to “whatever it takes to keep the labor market from softening further”, consistent with the dual mandate of the Federal Reserve for price stability and maximum employment, and frankly, consistent with the inflation mandate, because if the labor markets are in balance as I said, and expectations are anchored, then inflation will come down. They don't need the labor market to soften further.
So, Chairman Powell said, “we're shifting our focus”. We've got a restrictive monetary policy, and now it doesn't need to be so restrictive. We're going to ease off, and we're going to start cutting interest rates to make sure the labor market doesn't ease any further.
Dr. Guo:
Is that widely shared among the audience?
Dr. Kohn:
I think it was. I think his comments were perhaps a little more forward-leaning in the easing direction than some of his colleagues on the Federal Open Market Committee (FOMC) expected.
I think most FOMC policymakers were comfortable cutting rates in September, particularly after the July employment report. That wasn't the problem, or that wasn't an issue. The issue is how much and how far to continue and how much focus (to put) on the labor market.
So, my sense from my discussions with some of the other policymakers was, Chairman Powell focused on just how intent he was on shifting to the labor market objective, not paying attention to how much confidence they should have about inflation. They were not quite there yet.
Many of his colleagues on the FOMC in their public statements have talked about gradual and measured pace of easing. He didn't do that at all. So, I think they were with him 90% of the way he went, but maybe he went a little bit further than they expected.
Dr. Guo:
That was my impression.
Dr. Kohn:
But overall, maybe a better and clear answer to your question is, I think there was a lot of optimism that the inflation picture was looking much better. And there was a marked contrast to Jackson Hole in 2023 or 2022, when everybody was focused on the high inflation: Would it come down? What would the last mile look like? Would there have to be a recession in order to get inflation down?
So, I think there was a lot of optimism about a soft landing in the United States and inflation coming down. It was a generally much more relaxed Jackson Hole than it had been in the previous two years, and a more optimistic Jackson Hole.
Dr. Guo:
Speaking of a soft landing, if you look back a year or two years ago, nobody thought the U.S. economy would be in this place this year. You’ve got inflation basically to 2.5%-3% range. The economy is performing very, very strongly. It looks like almost a perfect soft landing.
Why was there no pain in this disinflationary process? Why did those doomsday predictions never materialize?
Dr. Kohn:
I don't think it's fair to say that no one thought this was possible. Chairman Powell himself talked about a narrow path to the soft landing, but with risks, right?
There were some very prominent economists who thought we would have to have a pretty severe recession in order to get inflation down. As economists, let’s think about supply and demand: on the supply side of the labor market, we did have immigration, and we did have some people returning to participating in the labor force to increase the labor supply.
On the demand side, the immigrants also contributed to demand, but they probably contributed a bit more to supply than demand. You had monetary policy tightening 500 basis points in just a year and a half or two, and that certainly took some of the steam out of demand.
Then, some people including Governor Waller at the Fed noted that it's quite possible that tightening demand would decrease the business demand for labor by decreasing the openings without necessarily increasing the unemployment rate. He talked about the Beveridge curve which relates vacancies to unemployment, and he thought you could move down that Beveridge curve. The pessimists thought that the Beveridge curve was flatter but I think he had a hypothesis that this might work this way, and it did.
And I think we were on a very nonlinear piece of the Phillips curve, which is the curve that relates inflation to unemployment. You get to a certain point and it starts pointing north, so reductions in the unemployment rate give you very high inflation. That's what we got in 2021 and 2022, but it also means you could slide back down, and if you reduce demand enough, then you will reduce inflation with only a small increase in the unemployment rate, and that's what we've had, with the unemployment rate gone from about 3.5% to 4.25%.
Dr. Guo:
If Philips curve is like what you describe, I think you are thinking about a kinked version of Philips curve or an L-shaped one.
Dr. Kohn:
Or at least nonlinear shape, right.
Dr. Guo:
Suppose that we are living in that world, are we entering the nonlinear part, or the more difficult part of the curve?
Dr. Kohn:
It's quite possible. I think governor Waller himself said he was worried that if the unemployment rate got to 4.5%—that was the good part of the curve—and then if it had to go past 4.5% in order to get inflation down, we were on the part of the curve where there have to be much bigger increase (in unemployment).
I don't know what Governor Waller would say, but I do think that so far it looks like we really slid down the part before the kink or before the curve, and so far have avoided the big increases in unemployment.
Dr. Guo:
During the Jackson Hole speech, Chairman Powell refused to comment on the exact level of R*. But when you try to think about how restrictive the policy is, you probably need to have some idea where R* is and where it could be. Are we living in a different world now compared to the pre-pandemic era that R* has moved around a little bit, and where is it now?
Dr. Kohn:
As I said in the Summit this morning, we really don't know. There's a huge amount of uncertainty around where R* is. I think it's a useful concept, but maybe less useful because it's not precise, and we don't really know ahead of time. It's not as useful in policymaking as it would be if we really knew.
Whereas in the 2010s, it looked like in real terms R* was about 0.5%, very low. But now, we have a situation where, with the growth in the federal government debt and the investments in green technology and AI, the investment-saving balance has shifted.
Although the demographics are the same, and so far AI hasn't really shown up in productivity, I still think the savings-investment balance suggests that R* is probably somewhat higher than it was in the 2010s, but we don't know.
Policymakers need to keep that in mind and not pretend they know with precision.
Chairman Powell’s first speech at Jackson Hole after he became Chairman was about the dangers of being guided by the “stars”, the uncertainty about where U* was, the long-term unemployment rate, and R*, etc. I hope that he remembers the first speech he gave and will treat estimates of R* with a great deal of caution.
Dr. Guo:
We were never in FOMC meeting rooms. Has R* ever been a framework of the committee to think about how to do monetary policy, or it this really just some reference that they keep back in their mind? I don't know how important this is.
Dr. Kohn:
I haven't been in the meeting room since 2010, so it's been 14 years since I was in an FOMC meeting. When I was on the staff and supplying material to the FOMC and when I was making decisions, it was something I looked at, and it gave me a sense of where I was relatively. Does this make sense? Why might it be higher or lower? Why might the policy rate need to be higher or lower? So, it was something to think about, but it wasn't something to make policy by in a mechanical way.
And I hope that's what people are doing now—especially through the Covid period and the post-Covid period, when the situation is so unprecedented and not part of the models—that they treat this with a great deal of caution.
Dr. Guo:
Let's move on.
The Fed has done forward guidance after the Global Financial Crisis as part of the unconventional monetary policy. Recently, the Fed has become data-dependent, almost refusing to give any further guidance on where the policy would be. It's somewhat like the good old days, like when you were in there. The Fed wasn't doing any forward guidance at the time, and it was also data-dependent.
But I sense there are some differences recently, because as the Fed becomes data-dependent, with every data release, from FOMC meeting to meeting, from press conference to press conference, there's a lot of volatility in the financial markets simply because they were guessing what the Fed would be doing or what it would not be doing. So, why has the market become so volatile and so data-sensitive now, compared to the Greenspan era or the early Ben Bernanke era when the Fed also didn’t have forward guidance and was data-dependent, but at that time the market responded okay to those data?
Dr. Kohn:
I'm actually not sure whether empirically markets are more volatile now in response to data than they were before. That was the premise of your question that they are. Let me accept the premise to your question and think about it.
Part of it is the experience of living through this Covid period. The best practice of central banking is the target of forecast, because you know there are lags between what the central bank does and its effect on output and inflation, so you should be targeting a forecast.
But I think what happened during Covid given the unique circumstances globally, with the disruption of supply chain, shutdowns and all that kind of things, was that the forecasts of inflation—which were made that inflation would come back down very quickly as soon as the supply chains opened up—were wrong, and inflation turned out to be much more persistent than the central banks and most private forecasters expected.
So, I think they lost a lot of confidence in the forecast, for good reason. And that meant that to figure out what to do, you had to pay more attention to the incoming data. Incoming data is always important because, even if you're operating on forecast, you might modify your forecast based on the incoming data. If it looked like the story you were telling wasn't right and the data didn't confirm it, you had to change your story and rethink things, but that was perhaps a little absorbed, to some extent, in the forecast: it wasn't so point-for-point.
But when you don't have much confidence in the forecast, it gives more emphasis on the incoming data, and especially the incoming data on inflation, as central banks are putting emphasis on getting inflation down. They've been wrong about it before. Inflation is at the end of a long chain of causation between monetary policy and inflation. You were looking at the end of the chain, and it raises the risk that you would be late to act.
So, I think the central banks are migrating back to a more forecast-based approach to policy. When Chair Powell talks about the data, he says incoming data and “its effect on the forecast”, and that's important. I hope that this migration happens and it gets more forecast-based.
I was reading some material of speeches by Alan Greenspan for a research project that I was doing on the 1980s and 1990s, and he said we have to be forecast-based. We will make mistakes, and our goal is to always keep our eye on the price stability goal, and to minimize the mistakes, recognize when something went wrong, and correct it.
I thought that was a very healthy attitude to recognize that we are human beings. We don't have perfect foresight, we make mistakes. And as central bankers, we just need to try and reduce any adverse implications of the mistakes we make. Recognize them quickly.
Dr. Guo:
One more question related to forward guidance. The Fed started publishing this dot plot some 10 years ago.
When I look at this dot plot, it is a compilation of individual forecast. But when you put them together, the current dot plot suggests that the Fed sees the medium-term federal fund rate at 2.8%, medium-term growth at 2%, and medium-term inflation at 2%. So, if you really take that seriously, it suggests that the Committee a had a median estimate of neutral rate around 0.8%, And there's a lot of dispersion among them.
I just cannot square my head. I found those numbers not consistent, because it's a combination of different forecasts. They give you a somewhat misleading picture. It may not necessarily be consistent.
Dr. Kohn:
I agree. I think there's a problem putting so much emphasis on the median forecast. There is a dispersion. There isn't one forecast. I think there is, on the part of the Federal Reserve as well as the people looking at the Federal Reserve forecasters, inadequate attention to the amount of uncertainty around these things.
“Median” is the median of a fairly small distribution of 19 people when they're in full strength. Often it was fewer than that, 17 or 16 people, so I think it can be misleading. You can have a median that can change with one or two people changing their minds.
One suggestion I would have is to not publish the median and not use it in the press conference. Now, Chair Powell is always very careful to say, this is not a plan, this is what will happen if the forecast happens, and we can change our mind, we make decisions meeting by meeting. But I think the Fed could try and figure out a better way of communicating the uncertainty and dispersion.
I just wouldn't publish the median. Other people will calculate it, that's fine, but it's different when the Federal Reserve calculates and then uses it in their communication. I would try to find some way of looking at the uncertainty.
A number of people have suggested that the forecast be grouped, so that a particular dot is associated with a particular forecast of GDP and a particular (inflation)…
Dr. Guo:
Number one is this dot. Number two is this dot.
Dr. Kohn:
Yes. And you don't even have to identify the people. At least as outsiders, you and I could observe, in general, the reaction functions, and how the members of the Committee saw the reaction function. I think that would be constructive.
Dr. Guo:
Interesting. Speaking of this, I guess the Fed will start to review its monetary policy framework sometime this year. It last reviewed and changed policy framework in 2020, I think.
Dr. Kohn:
That's correct.
Dr. Guo:
Do you think the Fed needs to change anything to its policy framework, given what happened in the past several years?
Dr. Kohn:
The first thing it needs to do is take a look at the last several years and analyze what happened, including what was done right, what might have gone wrong, and what lessons are to be learned from the last 5 years.
I think that's to your point. That's where to start this process. The 2020 framework was put into place at the end of the 2010s when inflation was low and interest rates were low, often at zero. There was a risk that inflation would be persistently below the 2% target and inflation expectations would drop down, so the nominal rates would be even lower, which would make the zero lower bound (ZLB) even more of a constraint.
All the emphasis in 2020 (framework) was how do we cope with the low inflation, low R* world? In the low inflation, low R*, low nominal rates world, we would face a downward asymmetry, where you can't ease policy enough to offset negative shocks to demand, and you are going to miss your employment and inflation target in a systematic way.
So, let's offset that with some inflationary aspects. There were two inflationary aspects to the 2020 framework. One was of an inflation averaging, so that if inflation ran low, they would let it run above the target for a while. They didn't say how much and how long, but above the target. But they never said if inflation runs high, we're going to run it low. They just said you will make up for low (inflation), but not for high (inflation).
Dr. Guo:
Asymmetric.
Dr. Kohn:
Asymmetric targeting. And the other asymmetry was with respect to labor markets.
They said, if we think that employment is below its maximum level and the unemployment rate is too high, we will pay attention to that, and that will cause us to ease policy. But if we think the unemployment rate is too low, and employment is too high, that's not going to cause us to tighten policy.
So, there was an asymmetry on the labor markets, and I would take a very careful look at that asymmetry. As I said, I had been looking at some of the policies of Volcker and Greenspan in the 1980s and 1990s. Particularly Greenspan's policies, but Volcker’s as well, were preemptive, which means when seeing tightening in the labor markets, the Fed would raise rates before it shows up in inflation. By having the asymmetry in the labor market, the 2020 framework kind of ruled out the preemption.
Dr. Guo:
It's almost by design. You will be behind the curve if inflation shoot up.
Dr. Kohn:
But they saw that as offsetting the other problem of the zero lower bound. But they had two ways of offsetting, and I don't know that they need it both ways. So, I would take a careful look at that. I would make sure that the new framework was robust to a variety of different circumstances. It has to remain robust to the potential for a low inflation, lower R* world; but it should also be robust to a higher inflation and adverse supply shocks kind of world. And I think the 2020 (framework) wasn't, so they need to stress-test their framework for that.
The other thing they need to do is think about the tools. When they say we're going to look at our framework, they talk about strategy, tools and communication. Last time they didn't look at tools and communication at all. We already talked about a communication issue. How do you convey the uncertainty around these things?
They ought to be looking at the forward guidance and how they used it, and whether that was an issue with making them late to lift off. I think it was, and I think they could do a better job and give themselves more flexibility as things evolved.
They should also look at the QE: whether it was too large, carried on too long, or did it include mortgage-backed securities at the time when the real estate market was already very hot?
So, there are important lessons learned in the tool side as well as the strategy side.
Dr. Guo:
Speaking of this, is that an intrinsic dynamic inconsistency problem of forward guidance, if you really cannot foresee the future so well?
Back in 2008, when the Fed did forward guidance, they were so sure that the economy would be in a very subdued state for quite a long period of time, so they said we're going to keep rates low for a very, very long period of time.
Dr. Kohn:
For an extended period.
Dr. Guo:
Yes, and the Fed turned out to be right. This time around, the pandemic hit, and nobody knew what would happen.
Dr. Kohn:
Sure. The forward guidance in 2008, 2009 and 2010 was kind of vague. “Extended period”, what does that mean? It wasn't defined.
This time, they defined it in terms of where the employment would be. They said, we are going to keep interest rates at zero until the economy is at full employment. They were judging that by the unemployment rate.
So, even though the vacancy rates were very high and labor market looked very tight, the unemployment rate was still a little high towards the end of 2021, so they didn't even trigger the phasedown of QE and then the raising of interest rates for a while.
Keeping the rates at zero until full employment implies that the highest real rate might be -2% at full employment. That doesn't sound like a good idea.
So, I think they got more specific because it was more effective in affecting expectations, but it tied their hands in an unproductive way.
Dr. Guo:
Right. That's what I guess the classical literature will call the dynamic inconsistency. It helps you at the beginning. It won't bite you until later, and you cannot do it over and over again.
Dr. Kohn:
Right. They were consistent with their guidance, but it was a mistake.
Dr. Guo:
Speaking of unconventional monetary policy, I have a sense that after so many years of unconventional monetary policy—I think the Bank for International Settlements (BIS) had a paper on this—it was almost accepted as if this will be a part of the regular toolbox of central banks. Are you uncomfortable with that? Is monetary policy trying to do too much?
Dr. Kohn:
I’m comfortable with unconventional policy being part of the regular toolbox, when the interest rate tool is constrained.
I think every central bank looks at their interest rate tool—for example, the bank rate in the UK, and the federal funds rate in the US—as their basic tool, the one they want to vary, the one they're used to using, and the one they think they have some empirical evidence about the effects of it going up and down. It's only when it's constrained that they'll go to the unconventional policy. And I don't see anything wrong with that.
If you did get to the zero lower bound and the economy needs stimulus, fiscal policy would be one way to do it, but fiscal policy isn't always available, and it takes a long time, etc. I think finding ways to make monetary policy more effective at zero is perfectly legitimate. You need to think through exactly how to use those things, how to structure them, and how to communicate about them. So, I think there are some lessons to be learned, but it's a legitimate tool at the zero lower bound.
Dr. Guo:
Professor Rajan wrote a lot of papers about the unintended consequences of unconventional monetary policy or ultra-loose monetary policy. Essentially, financial institutions get addicted to liquidity. The Fed was perceived as putting a put on any asset market dysfunction. Is that a problem?
Dr. Kohn:
There is a moral hazard problem from frequent interventions in the market. People could get relaxed about that. I think you can take care of that on the banking side, where there's regulation requiring more capital and more liquidity. You can balance that moral hazard by making the banks safer than they would choose if they weren't regulated.
It's harder in the non-banking side. I don't entirely agree with Professor Rajan about the liquidity thing. To some extent, I wonder if it was the zero interest rate, rather than liquidity, that incentivized the banks to take risks by lengthening interest rate risk, as Silicon Valley Bank (SVB) and Signature Bank did, by making longer term loans with short term deposits at zero rate.
So, I do think the unconventional policies affected the incentives, and the bank should have been more alert to the possibility that they weren’t going to last forever and control their interest rate risk better. I think the bank supervisors clearly fell down on the job. They should have worked harder with the banks.
As Professor Rajan said this morning, we don't know what's going on in the nonbank sector. We don't have good information. I think the Biden administration under the leadership of Secretary Yellen has pushed towards getting more information on the nonbank sector, trying to identify risks and work with the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) on that. But it's a challenge.
Dr. Guo:
Speaking of SVB, were you surprised by the fact that one of the nearest crisis after the global financial crisis was happening to some banks, the best regulated part of the financial system, rather than to the nonbank part?
Dr. Kohn:
Yes, I was. It's clear, and the Federal Reserve wrote an after-action report that said that its supervision of Silicon Valley Bank was not good or adequate. And so, I was surprised and disappointed by that, yes.
Dr. Guo:
What actually surprised me most was that, these were still relatively small banks, but they triggered systemic risk exemption from the Fed to provide very extraordinary guarantees. That part actually made me a little bit nervous. In your view, what is systemic risk? If such a small bank could trigger such massive response, then I guess there won't be any non-systematic risk.
Dr. Kohn:
I think the problem was not if that bank had failed and it was isolated, or if that bank and Signature Bank had both failed and that was isolated, but no one knew whether it was isolated. And the contagion was not about that this bank is systemic or that bank is systemic, but that it signaled that there were wider problems in the banking system, particularly among the large regional banks.
Those banks had come to rely on uninsured deposits. You can move your deposit with your phone. It doesn't take much effort. Besides, the information about people being worried about the safety of deposit spreads instantaneously through social media, and then people can take out their deposits instantaneously.
So, I think it's a new world of the way information flows and the way people are able to access their deposits that the regulators didn't take sufficient account of, and particularly, these uninsured deposits are where there was an incentive to run if you thought the bank was in trouble.
Now, the regulators have acted to correct their assumptions, and to work with the banks to do a better job on interest rate risk and liquidity risk that's been a big emphasis.
Dr. Guo:
I was actually also a little bit surprised that the Fed itself didn't really step in in time to stop the run on a single bank. In my view, that probably can be easily stopped if the Fed or the San Francisco Fed stepped in, opening up its discount window or whatever, as a traditional lender of last resort, then it could stop it very quickly.
Dr. Kohn:
One of the things that was revealed by that crisis was that the operation of the discount window was not as smooth or easy to use as people thought it might be.
Silicon Valley Bank, for example, had borrowed from the Federal Home Loan Banks, another agency that's often referred to as the “l(fā)ender of second last resort”. And it had trouble moving the collateral it had put there over to the Fed.
These are things that the Federal Reserve is working on now. Among the things it's in the process of requiring banks to have collateral at the Federal Reserve show that they can access that liquidity; by testing these lines, the bank should demonstrate that it has the technical capability and the Federal Reserve had the technical capability to make funds immediately available, and to accept that borrowing from the discount window was a legitimate source of liquidity.
Part of the problem with our discount window in the United States—I don't know about China—is that there is stigma attached. It's the lender of last resort. If you're at the lender of last resort, it must be the last resort, so you've got a problem. I think they're trying to destigmatize the window to make its use a more regular thing, and for the supervisors to say it's okay to use the discount window, you can count on that.
So, it's a complex set of fix-ups to make the discount window more effective, but you're right. It needs to happen.
Dr. Guo:
I think our banks probably don't have that kind of stigma, because we just don't publish the names. We are borrowing from that kind of emergency liquidities.
Dr. Kohn:
We publish the names. Congress has required us to publish the names after two years. There's no requirement and we don't publish the names when they borrow. But sometimes people can figure it out, and sometimes on shareholder phone calls or things like that, the banks will say we've accessed the discount window. And that's when problems arise.
Dr. Guo:
You've been through the 2008 crisis. It was a housing crisis and then eventually a financial crisis. China has also been through a quite significant housing correction. Is there any lesson or advice that you gain from your experience in 2008 that you can speak to us about?
Dr. Kohn:
I think there are a couple of lessons, not only from 2008, but from past housing cycles in the United States.
One of them that I talked about this morning at the Summit was let the cycle go—don’t try to stop the fall in prices and cut back in activity required to correct the imbalance. Once the cycle starts to break, don't try to stop it, because it's going to have to go. What you should do is to concentrate on building resilience.
This goes to our previous conversation, building resilience in the system so that if house prices fall, banks aren't failing, and nonbanks aren't failing. So, you need to concentrate on that. You can't suppress…if you've created more houses, then there's demand for them. That correction has to happen.
Another lesson is that, in the United States in the 1980s, we had a housing cycle and savings and loan (S&L) institutions that made 30-year mortgages with overnight savings accounts.
When interest rates rose to fight inflation, the mortgage prices were down. Those guys were insolvent, and the government (not the Fed) tried a number of ways to keep them alive, and see if they could survive. That was a mistake. When the institution is insolvent, you've got to resolve it and get rid of it, and not try and stabilize the situation artificially.
Another issue, which is relevant to China today and it was certainly relevant to the U.S. in 2008 and 2009, is, when one of your sectors is cratering like that and subtracting from domestic demand, you've got to stimulate the other ones. It takes fiscal policy and monetary policy going all in.
At the Fed, we used to have discussions in the beginning of 2008 when it looked like things were shaky but hadn't really collapsed yet. Some people were arguing that we should keep some of our interest rate powder dry. We shouldn't use or we shouldn't be aggressive with easing. I think that was a mistake.
I thought we were pretty aggressive. I certainly argued in meetings for being aggressive, particularly when we got close to zero lower bound. It's better to get ahead of that problem. So, I think being aggressive with the easing to stabilize the economy even as the sector is adjusting is really important.
Another lesson that I don't know how to deal with really is, it struck me that right now the housing discussion in the United States is about shortage. So, we went from a situation in 2005, 2006 or 2007 of surplus to a situation 15 years later of shortage.
I wish I knew a way of leveling out that cycle, taking actions such as building resilience and raising capital requirements. When you see a sector that looks very ebullient and growing very rapidly, that's when risks are building up, and that's when you need to build up the capital.
To some extent, the regulators and the banking system may have overreacted to the problems of 2006 and 2007, or at least they should have found another way. So, after the crisis bank mortgage lending went only to the very safest borrowers. That, I think, has helped to contribute to the shortage.
Now there are lots of other things contributing to the shortage and the supply side of the housing market, including regulations about building and where you can build, and the restrictions, etc. But I do think it's not so much a central bank problem, but perhaps a government problem, thinking about stopping the up part of the cycle, and then not letting it overshoot on the downside so that 10 or 15 years later you're looking at the opposite problem.
Dr. Guo:
I have one or two last questions that I really want to ask.
One question: there's one similarity between China and the U.S. China has about 4,000 banks, many of them very small. I think the U.S. also has a lot of small banks. Do we really need that many small banks?
Dr. Kohn:
No. I don’t know the situation in China, but in the United States, for many years until the 1990s, there were restrictions on banking across state borders, and so many particularly agricultural areas had little banks, because the big banks couldn't come in or merge with them. And that was inefficient, and it was not a very effective banking system. So, we've lost a number of banks. I don't know the numbers, but it's probably dropped by half over the last 10 or 20 years since those restrictions were taken off and more mergers are inevitable.
Having said all that, community banks and the regional banks have a very valuable role to play in knowing the customers in their service area. We know that banking is all about asymmetric information. The borrowers know more than the lenders, but where the lenders are based in the area and they know the borrowers, they can even that out, make better credit calls, and understand when they can take risks and when they shouldn't be taking risks.
So, I think going into a system that has nothing but very large banks is also a mistake, because it will tend to cut off credit to some of the newer or smaller businesses that (only) locally-based banks can see.
So, we need a mixture, but I think probably in both countries, we need to let that consolidation process continue for a little while.
Dr. Guo:
One final question. I know during your days, the Fed probably didn’t care too much about what other central banks were doing, unless it had impact on U.S. inflation. I remember back in 2015 or 2016, the Fed explicitly said that something happened overseas, which was why it was not hiking rate then. I think that was a time when China had some domestic volatility and the Fed decided not to hike, and just to wait and see what's going to happen.
Given the change of global economy, the size of China and the importance of other economies, is the Fed now also affected by spillovers from other central banks and other economies, or is it still operating in an environment that still treats the U.S. almost like a closed economy?
Dr. Kohn:
I don't agree with your description. I think we've always discussed global economic conditions at Open Market Committee meetings, and when I was on staff, I provided projections of overseas economic growth in emerging markets and industrial countries, and took account of the feedback on the U.S.
Now, it is true that the U.S. is very, very large compared to most other countries for a lot of this time, but other countries including China and other emerging market economies are growing bigger.
I am sure and I know that this is part of the considerations. Let's go back. You said 2015. I worked on the speech with Chairman Greenspan in 1998 during the Asian Financial Crisis, where he said the U.S. economy couldn’t be an island unaffected by what's going on in the rest of the world. That was a time when the U.S. were raising rates, and we stopped raising rates and eventually eased rates a little bit in 1998 because of the effects of the Asian Financial Crisis.
So, I think that's always been a part of it. It's probably more and more important as the rest of the world grows relative to the U.S.
Dr. Guo:
Okay. Thank you, Don. Such a wonderful conversation.
Dr. Kohn:
Very good. Thank you. Bye.
