Narayana Kocherlakota: Economics at the Federal Reserve Banks
Opening statement by Mr Narayana Kocherlakota, President of the Federal Reserve Bank of
Minneapolis, at the Panel Discussion, American Economic Association Annual Meeting,
Philadelphia, Pennsylvania, 4 January 2014.
* * *
I thank Dave Fettig and Sam Schulhofer-Wohl for their helpful comments.
I'd like to use this opportunity to talk about the role of economic research and economists
within a Reserve Bank. My main theme is that, to be successful at their host of
responsibilities, Reserve Banks need economists with a wide range of perspectives and
skills. Conversely, economists in a variety of fields can enjoy fulfilling and successful careers
at Reserve Banks. I'll illustrate my points by using examples from my own institution, the
Federal Reserve Bank of Minneapolis.
The views that I express today are my own and not necessarily those of others in the Federal
Reserve System, including my colleagues on the Federal Open Market Committee.
My first observation is that, just like economists who work at universities and colleges, many
economists within Reserve Banks spend a great deal of time on independent research. Many
Reserve Banks - including the Minneapolis Federal Reserve Bank - have found that,
especially over the longer term, this self-directed research has the power to create valuable
new insights into important public policy questions. For example, back in the 1990s, Harold
Cole and Lee Ohanian - then at the Minneapolis Fed - developed an exciting and important
new way to think about the slow recovery during the Great Depression.1 This work in
economic history has turned out to be a valuable resource for many who are thinking about
the current slow recovery.
Over the past four decades in Minneapolis, we have found that, to be effective, independent
research should follow the usual rules of academic economics. More specifically, economists
must be free to pursue any question, use any available tools and arrive at any answer. The
quality of those answers is ultimately measured by rigorous academic peer review, not by
internal managerial judgment.
So, university and Reserve Bank jobs are not all that different in terms of the role of
independent research. What distinguishes academic jobs from Reserve Bank jobs for
economists is how they spend their non-research time. Economists with academic jobs
spend most of their non-research time teaching. Economists with Reserve Bank jobs spend
most of their non-research time supporting public policy work. As I stated at the outset, my
main theme today is that public policy work in a Reserve Bank relies on a much wider variety
of economic specializations than might be generally appreciated.
I'll start by talking about the most visible of the Fed's public policy responsibilities: monetary
policy. The president of each Reserve Bank participates in the Federal Open Market
Committee (FOMC) meetings. Economists play a key role in briefing and generally
supporting their president's involvement in those meetings. I'm sure that I won't be telling the
people in this room anything new when I say that many of these economists are skilled at
macroeconomic modeling. Indeed, there are many kinds of macroeconomic models,
grounded in a wide range of underlying perspectives. To be most effective, an FOMC
participant's support team has to engage fully with this plethora of approaches.
I suspect, too, that many in this room will not be surprised to hear that to be effective,
presidents of Reserve Banks need support from economists with expertise in financial
economics. After all, the Fed implements its monetary policy actions through financial market
transactions. Monetary policy advice needs to be grounded in a keen understanding of
financial markets, and the linkages between those markets and the broader macroeconomy.
As well, financial markets are important to policymakers as a source of information about the
public's expectations for the future. At the Minneapolis Fed, we continue to work on how best
to use information in asset prices - as encoded in so-called risk-neutral probabilities - to
inform monetary policy choices.2 This is a joint effort that involves several parts of the Bank,
and we have benefited from interactions with other economists around the System and in
academe. We see it as a critical area for future research.
What is perhaps less understood is that people who are not specialists in macroeconomics
or finance also play a key role in monetary policy support. For example, the Fed is charged
with making monetary policy so as to promote maximum employment. The challenge is that
the level of employment that is indeed maximal is largely outside the control of monetary
policy and, moreover, varies over time. Hence, the Fed engages in continual efforts to obtain
measures of the maximum level of employment. These efforts are fundamentally grounded in
the work of many labor economists around the System, but I'll cite an important recent
example done in Minneapolis. My research director, Sam Schulhofer-Wohl, and his co-author
and former Minneapolis Fed economist Greg Kaplan closely studied the recent decline in
internal migration in the United States.3 Some policymakers had expressed concern that this
decline indicated that the Great Recession had caused a sudden increase in structural
unemployment. But Sam and Greg's research provided compelling evidence that this view
was mistaken - rather, the decline in internal migration was better understood as being part
of a very long-run trend.
Let me transit to another Fed responsibility: supervision of financial institutions. The financial
crisis made clear the fundamental linkage between the condition of large financial institutions
and the macroeconomy. That lesson has translated into a more complete integration of
economists - with expertise in banking, finance and macroeconomics - and the supervision
of financial institutions. Monetary policymakers continually assess systemic financial risks,
and this assessment is informed in part by supervisory information. Conversely, economists
contribute to the supervision process by helping to build a better understanding of risks that
face the financial sector.
I could illustrate this Systemwide effort to build more connections between economics and
supervision in many ways. I'll just mention two of the several lines of attack undertaken in
Minneapolis. Minneapolis Fed economist Motohiro Yogo and his co-author Ralph Koijen are
studying the incentive effects of regulatory policies on insurers' risk-taking. Their work has
shed important new light on "shadow insurance" risks from off-balance-sheet liabilities of life
insurance companies.4 As well, my head of supervision, Ron Feldman, and his team are
using option price data - again, as encoded in risk-neutral probabilities - as a source of
information about tail risks for large financial institutions.5
I've talked a lot about monetary policy and the supervision of financial institutions. But these
are only two of the many public policy roles of Reserve Banks. Let me briefly mention a
couple more: the payments system and community development. Reserve Banks have
recently formulated an ambitious strategic plan regarding their responsibilities in the
payments system - the variety of mechanisms by which people and businesses transfer
funds to one another. This strategic plan was informed in part by contributions from a large
number of economists around the System who specialize in payments systems. In terms of
community development, Reserve Banks engage in a number of activities to encourage
private-sector investment in low- and moderate-income communities. Microeconomic
analysis underpins these activities in important ways. For example, in Minneapolis, over the
past dozen years, our Community Development function has worked closely with tribal
representatives on initiatives to help Native American tribes select and build a sound legal
infrastructure that can support private business development in Indian Country. We are
engaged in efforts to buttress this work by using microeconometric techniques to measure
the impact of these legal infrastructure improvements on economic outcomes.
I have argued that Reserve Banks need a wide range of skills and perspectives to fulfill their
public policy missions. These considerations have helped inform the evolution of our
Research department in Minneapolis in the past four plus years since I became president. In
that time, we've greatly expanded the group, by hiring folks from top universities like
Stanford, Penn and Princeton, as well as from elsewhere in the Federal Reserve System.
These new economists have skills in financial economics, labor economics, international
economics, econometric forecasting and monetary economics. The department's expansion
has helped make the Minneapolis Fed even more agile and effective with respect to its public
policy contributions, while maintaining its historical excellence with respect to independent
research.
But the skill diversity that I've been emphasizing is valued throughout the Federal Reserve
System, not just in Minneapolis. To see this, one need not look any further than the key
Research leadership positions around the Federal Reserve System. The Research director
in Philadelphia is an economist with expertise in banking. The Research director in Chicago
is an economist with expertise in labor economics and industrial organization. The Research
director in New York is an economist with expertise in payments systems.
I've described a Federal Reserve System in which each Reserve Bank has a broad-based
group of economists. Some listeners might ask: Why not put all the economists in
Washington? Or why not have each bank specialize in a different subfield of economics? I
have a couple of answers to these questions. The first is grounded in the nature of monetary
policymaking at the Federal Reserve. The essence of the Federal Reserve System is that
each of the 12 Reserve Bank presidents brings a distinct perspective to monetary policy
deliberations. But these perspectives need to be appropriately informed by economic
analysis - and, as I've argued, that kind of support requires a broad range of skills to be
effective.
Second, I view geographic diversity as a necessary ingredient to generating valuable
intellectual diversity across the System. Back in the 1970s, the Minneapolis Fed Research
department played a key role in fostering the "rational expectations revolution" that has
helped transform the making of monetary policy around the world. Would these economists
have played this same role had they been working in Washington - or anywhere else in the
System, for that matter? I believe that the answer to this question is no. The ideas in the
Research department were generated by synergistic interactions between Minneapolis Fed
economists and University of Minnesota economists - synergies that owed a lot to the
geographical proximity between the two institutions. I see those same intellectual synergies
as critical to the Minneapolis Fed's, and the System's, thinking as we move forward.
Let me sum up.
Most of you know that many economists work in Reserve Banks. What I wanted to
communicate to you today is that these economists have many different fields of
specialization. This diversity is essential - Reserve Banks need that large variety of skills to
fulfill our public policy missions. As a result, many kinds of economists can enjoy successful
careers within the Federal Reserve. What it takes to be successful in our organization as an
economist is extraordinary dedication to, and belief in, our public policy mission.