Leading the Minneapolis Fed

Narayana Kocherlakota, at 47 the youngest Federal Reserve Bank president in the country, has been leading the Minneapolis bank for 14 months, preparing to join the Federal Open Market Committee, the group of 12 gurus who set the nation's interest rate policy. The new responsibility starts next month.. Kocherlakota, born in Maryland, raised in Winnipeg, will bring his academic prowess in economics to the practical public policy work of the FOMC. The son of two college professors, Kocherlakota entered Princeton University at age 15 and studied mathematics, ultimately getting a Ph.D., from the University of Chicago in 1987. Since then, he has been a professor at Stanford and the University of Minnesota, as well as an assistant professor at Northwestern University and at the University of Iowa. He chaired the economics department at the University of Minnesota for two years.. Having consulted to the Fed along side his teaching duties for 10 years, Kocherlakota was a familiar face around the Kasota-stone building on the Mississippi River in downtown Minneapolis. Replacing Gary Stern as Minneapolis Fed Bank president not only means transitioning from academics to real world central banking, but putting on a suit and tie every day, a significant departure from the typical attire of those inhabiting the Fed's research department.. The economy's performance over the last three years has broken many of the established models, those built on the notion that real estate values always go up. With monetary policy handcuffed by record low interest rates and economists looking for more dependable predictive models, it's an interesting time to be joining the FOMC.. "One thing I have learned over my years in economics is the importance of being open to new ideas and the last three years has underscored that for me," Kocherlakota said in an interview in the conference room outside his office. "You have to be willing to change your ideas in light of that. As you go through life as an academic, where you start from is not where you end up. It is about the process, not about where you are at any given point in time.". Kocherlakota said the previous mainstream thinking about the economy essentially took the banks for granted. "There was a tendency to de-emphasize the role of banking and finance in our understanding of macroeconomics, that those markets would run themselves. That vision has been exploded." .Communication is key. Having focused on macroeconomics for most of his career, Kocherlakota admits to having needed a primer on bank supervision. He said, however, that monetary policy and bank supervision are not mutually exclusive. The information gathering component of monetary policy work is something that matches up nicely with supervision, he said.. "I find the information that I get in my role of supervisor really important to me in the way I think about monetary policy. This is especially true right now when we are thinking about why isn't there more hiring going on, why isn't their more employment growth? One thing you can certainly think about is small businesses and how important they are to employment growth. Small businesses disproportionately rely on smaller banks as a source of financing and so talking to community bankers and learning from them is very important.". The Federal Reserve Board announced in October it is creating a Community Depository Institutions Advisory Council to provide input on the economy, lending conditions and other issues. Kocherlakota said he is eager to work with community bankers through the new entity. The council will be made up of representatives from similar councils set up at each of the 12 reserve banks. The new structure replaces the Thrift Institutions Advisory Council, which was created in 1980. The new councils on the reserve bank level will begin meeting in 2011, with the board advisory council beginning in 2012.. The combination of macroeconomic theory with practical real world data leads to significant policy decisions, a prospect that energizes Kocherlakota. He gave this example regarding the economic recession of 2009:. "One kind of shock is what I would call a net worth shock; that's basically people's homes and their stocks lost a lot of value. That reduced their ability to spend; their demand for consumption fell. So that was one kind of shock. Another kind of shock is allocational. We are building about a third the number of houses that we were building in 2006. People who were doing that kind of work have to be shifted into something else. A transition has to take place. So those are two kinds of shocks.. "Those different kinds of shocks lead one to think about different kinds of responses in terms of policy. What I hear sometimes in the media is some people emphasize the one kind of shock and that leads them to one kind of policy conclusion and others are emphasizing the second kind of shock and that leads them to another. If you are emphasizing the net worth shock, that leads you more to a fiscal policy kind of response. If you emphasize the allocational shock, it is a little harder to see what the government's role is in that but the fiscal policy intervention is less natural and you could be thinking about job retraining packages or other kinds of things that can help smooth the allocation process along." .Getting to know the district. The Ninth Federal Reserve District is vast, covering more than 400,000 square miles, fully 12 percent of the nation's land mass. The region is a hotbed of community banking with more than 700 banks, 75 percent of which have $150 million in assets or fewer. What does Kocherlakota make of the region?. "It is a diverse region in terms of mix of economic activities," he said. "You know Minnesota is pretty diverse. You go out into the Dakotas, it is much more resource agriculturally oriented. In the Dakotas, because of how well oil is doing there, you just get a very different picture, and the same is true in agriculture. Agriculture is doing very well; yields are high, prices are high.. "I think it is important for me to get out there to communicate to people, for me to learn about what is going on in terms of what is happening in the agricultural sector. That two-way conversation is very important and very useful.". And what of all these community banks in the region? What does Kocherlakota say about them?. "Community banks provide a clear value. That local information that typically comes from community banks is really valuable," he commented. "On the other hand, there are technological forces that are going to be challenging for smaller banks. So there are values in being small and there are values in being big and we'll have to see how those sort out.. "I think good policy should be careful not to subsidize one source versus the other," he continued. "It is not about deciding between the 8-track and the CD. I don't want to be involved in that game but you want to be clear that you are not subsidizing the 8-track when the CD is going to be the wave of the future.". Kocherlakota understands some of the competitive pressure that misguided public policy has created for smaller banks and sees a positive development in the recently passed Dodd-Frank Act.. "If some institutions are perceived to be too-big-to-fail, then their creditors will probably be willing to lend to them at a lower interest rate. That is an implicit form of subsidy," he noted. "Now that is something we want to be careful about and that is what the new legislation is all about.". Kocherlakota has visited with bankers in each state in the ninth district and said he is eager to bring his observations, as well as experience to his FOMC responsibilities. His first meeting as a voting member is set for Jan. 25-26.