In March 2017, the Federal Reserve increased the short-term interest rate for the third time since June 2006, signaling optimism in the economy. Narayana Kocherlakota ’83, who served as the 12th president of the Federal Reserve Bank of Minneapolis from 2009 to 2015, advocated against raising the rate during his term. He was a member of the Federal Open Markets Committee, which sets the interest rate by buying and selling U.S. Treasury securities. He is currently the Lionel W. McKenzie Professor of Economics at the University of Rochester, and he spoke to The Daily Princetonian about his Princeton experience and his views on current monetary policy.
The Daily Princetonian: Growing up in Canada, how did you decide you wanted to go to school in the United States? What attracted you to Princeton, and how did it feel to enter a university at the age of 15?
Narayana Kocherlakota: I don’t think that I thought about it in terms of coming to the U.S. — it was more about going to a university to get a good education. So, I applied to about five schools on both sides of the border. I knew Princeton’s tremendous reputation. I had visited there and had liked the campus. So I was delighted to have the opportunity to go to school there.
I didn’t, and don’t, think of coming to Princeton at the age of 15, soon to be 16, as being a big deal. I had been in classes with older kids for many years.
DP: How would you describe your Princeton experience, and what aspect of Princeton did you enjoy the most? What activities did you participate in, and what was your senior thesis about?
NK: I had a lot of fun being on the debate team in my freshman year, and on College Bowl in my last three years. I was, and am, a terrible athlete, but I took part in a large number of intramural sports, maybe eight or nine?
My senior thesis was about optimal income taxation, a topic to which, largely by happenstance, I returned later in my research.
I had a number of inspiring and influential professors and grad student TAs at Princeton, in math, econ, history, and political science.
I still find my anonymous answer to the Reserve Room Poll question, “When is seduction complete?” to be pretty darn funny. My answer was: “When the Cauchy sequences in the seduction space converge.” This appears in the bottom right on page 16 of the Sept. 21, 1981, issue of Princeton Alumni Weekly.
But, to be completely honest, I didn’t find attending Princeton as enjoyable as I later found attending the University of Chicago. Being successful at Princeton, at least back then, seemed to require being part of what I would call an East Coast social scene, eating clubs, etc. That didn’t come easy to me, as someone coming from a Canadian Prairie city, Winnipeg. Chicago, again back then, was mainly about the life of the mind. I liked that focus better. Perhaps put more simply — I was just too nerdy for Princeton! My answer above to the Reading Room poll may bear out this conclusion.
DP: After Princeton, you entered the University of Chicago for graduate studies in economics. What drew you to the field of economics, since you had previously majored in math? What was your Ph.D. research focused on?
NK: I had struggled as a sophomore about whether to major in math or apply to the Woodrow Wilson School. I ended up majoring in math, but I missed the policy orientation of the social science subjects that I had taken.
Then, during the summer after my junior year, I was doing some reading in my hometown university library. I found this book, “Mathematical Methods of Game and Economic Theory,” by the French economist Jean-Pierre Aubin that applied heavy-duty mathematics to problems in economics and the social sciences. I got tremendously excited about doing that kind of work.
So, as a senior, I focused on mathematical economics. Princeton was very strong in this area. My senior thesis advisor, Robert Anderson, had a joint appointment in math and economics.
My Ph.D. thesis at Chicago was on the implications of relaxing the expected utility hypothesis for the pricing of financial assets.
DP: You are probably most well-known for being one of the founders of the New Dynamic Public Finance. Could you describe what this theory entails, and how this could be applied to tax and unemployment policies?
NK: The New Dynamic Public Finance is largely concerned with the interaction between household saving decisions and social insurance against transitory or persistent falls in labor income, like those caused by disability or job loss. I would say that the main message of the research is that these kinds of social insurance programs are likely to be much more effective if they are implemented in conjunction with asset tests or taxes.
DP: In 2008, you signed a petition questioning the benefits of the Obama administration’s economic stimulus plan. What were your concerns with the plan, and what do you think of the economic results of the plan?
NK: I signed the petition because I felt that the administration was exaggerating the amount of empirical and theoretical support for their policies.
In the interim, we’ve seen a tremendous amount of high-quality empirical work on this question. I’ve come away convinced that, given some of the constraints on monetary policy, fiscal policy during this time frame was a net positive.
DP: When you were appointed to the Federal Reserve Bank of Minneapolis, what was your initial reaction? Was it difficult transitioning from academia to a government institution?
NK: I liked the transition enormously. I thought it was a huge honor to be working with such an amazing group of people on such important questions. The country was facing an economic emergency when I became Bank President in October 2009. It was immensely rewarding to play a part in the response to that emergency.
DP: How would you describe your experience serving on the Federal Open Markets Committee? During your time at the Federal Reserve, which accomplishment are you the most proud of?
NK: In terms of the FOMC: See above.
I would say that I’m most proud of leading the Federal Reserve Bank of Minneapolis to establish a Center for Indian Country Development. There is a large need for a better understanding of the causes and possible solutions for Native American economic underdevelopment. The CICD has the potential to serve as a nexus for this effort.
DP: Serving on the Federal Open Markets Committee, you initially voted against keeping the short-term interest rate near zero percent in 2011, but in 2015, you indicated that it would be a mistake to raise the interest rate. How would you describe your evolution on this issue, and what you think about the current plan to raise the interest rate?
NK: More precisely, in 2011, I voted against the FOMC’s decision to announce its intention to keep the short-term interest rate near zero percent for the next two years.
In 2011, I was worried that rising inflation was likely to exceed the Fed’s target of two percent on a persistent basis. Within a year, both labor market research and declining inflation convinced me that I was wrong in my concerns. So, since 2012, I’ve been arguing that the Fed needs to focus on making monetary policy more stimulative so as to push inflation back up to the two percent target on a sustainable basis in the next year or two.
Along those lines, I don’t see why the Fed is so eager to engage in further increases in the short-term interest rate, given how low inflation has been and seems likely to remain.
DP: How would you currently describe your research interests? Do you continue to focus on monetary policy, or are you exploring a new topic?
NK: I’m mainly focusing on monetary policy. The foundations of how macroeconomists think about monetary policy were largely laid in the early 1980s. I’m interested in reexamining those foundations in light of more recent data and theoretical developments.
I’m also doing some research in dynamic game theory with a couple of excellent Ph.D. students here at Rochester.
DP: What advice do you have for students who are interested in economics and economic policy?
NK: It’s a hugely exciting time to be involved in economic research. The field is being transformed by an influx of new data and computational power. We’re learning so much so fast.
And interpreting all of these data correctly will require the right kind of theoretical framework. So there continues to be a big need for research along those lines as well.