Meeting

C. Peter McColough Series on International Economics With Robert S. Kaplan

Tuesday, December 17, 2019
Speaker
Robert S. Kaplan

President and Chief Executive Officer, Federal Reserve Bank of Dallas

Presider

Adjunct Senior Fellow, Council on Foreign Relations

Robert Kaplan of the Federal Reserve Bank of Dallas discusses the importance of international trade, the global economy, and U.S. monetary policy.

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

BUITER: Good morning, fellow members. This is one of the C. Peter McColough Series on International Economics.

And I have the pleasure to welcome Robert Kaplan, president and chief executive of the Federal Reserve Bank of Dallas. Before that he spent time at Harvard Business School. Before that, twenty-three years at Goldman.

I’m Willem Buiter. I’m—will be, rather, visiting professor at Columbia starting January, and adjunct senior fellow at Council on Foreign Relations. And I have the pleasure to preside over this day’s proceedings.

Please put your phones on silent mode so we can proceed uninterrupted.

I’ll start by raising some issues with you. Three-and-a-half percent unemployment.

KAPLAN: Yes, sir.

BUITER: If I had been sitting here ten years ago, I would have been expecting double-digit inflation, certainly emphatic signs of upward pressure in the labor market. None of that. What accounts for this? And how much slack is left?

KAPLAN: So let me—let me start with the headline reason, I think, is structural, and probably is not being talked—there’s not enough talk about it in that technology, and particularly technology-enabled disruption, is a dramatic structural change that’s occurred just in the last really fifteen years that is limiting the pricing power of business more than at any time in our lifetime.

Now, most of you are sitting here saying, oh, come on, technology has been replacing people for all of our lives. What’s different is distributed computing and the fact that we each have in the palm of our hands more computing power than the typical company had just ten or fifteen years ago. The balance of power has dramatically shifted from the sellers of goods and services to the buyers of goods and services.

And we do a lot of work on this issue at the Dallas Fed. We’ve done two conferences on it. We’re about to do a third. And we think it’s creating a dramatic change in the way businesses are run.

And so the way businesses are dealing with this is to the extent they have cost increases, it’s just as likely to create margin erosion. It’s not that they don’t want to pass it on terms of prices; they can’t. And what businesses are doing is investing more in technology as a result, and they’re doing more merger activity because they need more scale to manage this phenomenon.

But what does it mean for the labor force? It means that we can run a tighter labor force than we have historically without at least pricing pressure. There is wage pressure, and more than people—the headline numbers may suggest, in that at the $12 to $15/hour range we find there’s a lot of—there’s a lot of wage pressure in the United States and a lot of churn. And for skilled workers, there’s a shortage of skilled workers and there’s lots of wage pressure there. Where there’s not wage pressure is in the middle. If you’re making $55,000 a year with benefits and you work at a good company, what we’re finding, particularly late in an economic cycle, is workers very rationally are willing to trade off the quality of their employer, the quality of their job for going after the extra X percent in terms of wages. And so there is wage pressure, but it’s for skilled and at the low end. But this structural change in terms of technology-enabled disruption is allowing us to run a hotter workforce than we would have ten, fifteen years ago.

So the typical Fed playbook would be you start getting to levels that you think are at or below full employment, you start raising the fed funds rate because you’re worried that inflation’s going to take off. I don’t think inflation’s going to take off. We’ve been saying this at the Dallas Fed for a few years now. We think inflation pressures are going to remain muted. It’s not that there aren’t cyclical inflation pressures; they are—there are. But they’re being more than offset by these powerful structural forces, which are by the way in our view intensifying.

BUITER: Inflation pressures are muted at current levels of unemployment, but how much scope is there for further reducing—you know, 3.4, 3.3, 3.2 (percent)?

KAPLAN: Our own view at the Dallas Fed is we’re going to grow next year around 2 percent, maybe a little bit more, and you’re going to see the unemployment rate pretty well stay stagnant around 3 ½ percent. The number we look at more than the headline unemployment rate is a—is a concept in the lingo called U-6, which is the number of unemployed, plus discouraged workers who’ve given up looking—out of the workforce—plus people working part-time who would prefer to work full-time but they’re counted in the workforce. That percentage to us is more relevant. That, though, is 6.9 percent.

And just to put it in context, the last time it was that low was during the dot-com boom, and the pre-recession low—i.e., ’06—it was something like 7.9 (percent). So we—if you look at that measure of slack, we are well below the pre-recession low and we’re at historically tight levels. All that tells me while there’s some slack, particularly in groups that haven’t been in the workforce that are being pulled in, there’s not that much slack. We think we’re at or past full employment in the United States.

BUITER: You mentioned that technological change has had a restraining effect on inflation, but you’ve also mentioned other secular drivers that have similar effects—demographics, distribution, and all that. Could you elaborate on those—

KAPLAN: Yeah. So there’s four—there’s four big structural drivers of the U.S. economy. And I’m a businessperson, so you want to know—I sit around the table with lots of Ph.D. economists, and as a—and I have thirty Ph.D. economists at the Dallas Fed, and we tend to do a lot of research on cyclical phenomena, things there’s lots of data on. I as a businessperson tend to look, in addition, a lot at structural drivers. There’s four big structural drivers that I see in the U.S. economy.

Number one is the workforce is aging. I wish we weren’t, but we are. And so what it means is workforce growth is slowing in the United States and the participation rate, all things being equal, is trending downward. We’ve stayed flat at 63 percent the last few years; that’s an enormous accomplishment. The participation rate in ’07, by the way, was 66 percent. The participation rate is those sixteen years old and older that are either in the workforce working or looking for work. It’s trending down. And we think over the next ten years it’s going to trend down to 61 percent, even though people are working longer. That’s a headwind for economic growth. GDP growth is made up of growth in the workforce and growth in productivity. And I’m telling you right now workforce growth in the United States, unless we make changes to immigration policy and other things we’re doing, workforce growth here is slowing. So that’s a headwind for GDP growth and probably has some restraining effect on prices.

The second one I mentioned, is technology, technology-enabled disruption. And I mentioned the impact on businesses. It’s got one other effect, and that’s on productivity. You would think with all this investment in technology productivity would be going like this—and oh, by the way, it is by industry and by business. But when we talk about productivity in terms of GDP, we talk about the workforce. We measure it workforce-wide. And what we’re finding in our work at the Dallas Fed is if you’ve got a college education, which is about two-thirds of the workforce or better, you’re benefitting from technology and technology-enabled disruption. You might have some traumas in your career, but your income—you’re likely to be in the workforce and it’s likely your income is going to go like this in your career, and your productivity. If on the other hand you’re one of the forty-six million workers in the United States that has a high-school education or lower, you’re increasingly seeing your job either restructured or eliminated. Think of the call-center worker, again, that makes $55,000 a year. That job ain’t going to exist five, seven years from now. And you’ll find another job in a tight labor market, but you may well be seeing your income and productivity go like this. When you average it all together, productivity growth in the United States is sluggish.

Our thought at the Dallas Fed, we feel strongly—which is why we spend to much time on this—is we’ve got to improve early childhood literacy, educational attainment, skills training. And we are lagging in the United States versus other countries, particularly on early childhood literacy, particularly on the fastest-growing demographics groups. You know, kids are not starting third grade reading at grade level, and it means lower productivity. And what’s the number-one skill we hear from employers you need to adapt to technology? Literacy—ability to read, write, and communicate. And we are—we are lagging the world in the United States. Oh, by the way, Texas lags the country. The country lags the world. So we’ve got to work more on that.

Last two, and I’ll do it quickly.

Globalization is the third drivers. Globalization is probably having also some muting effect on pricing power. Not as much, we don’t think, as technology. But the bigger concern we have about globalization, we think at the Dallas Fed globalization is an opportunity for the U.S. to grow faster. In a—in a society where your population is aging, you’re highly leveraged, you haven’t invested enough in your workforce and so you’re not as productive, integrating with the rest of the world is an enormous opportunity. But right now the narrative in the United States is if you’re losing your job in Wisconsin or Michigan, it’s probably due to either an immigrant or it’s due to a lousy trade deal. That probably was true fifteen years ago. Today if you’re losing your job in one of those places it’s probably due to technology and technology-enabled disruption. And if we get that diagnosis wrong, we’re going to make policies that are going to cause us to—de-globalization will mean slower growth.

And then the last big issue, none of this would matter all that much—it would matter, but not that much—if we weren’t so highly leveraged in the United States. So the household sector’s deleveraged over the last ten years; that’s good news. And the households are 70 percent of the economy, as you know, Willem. And the corporates, nonfinancial corporates are historically highly leveraged, but the government is now on a—we think an unsustainable path: 77 percent of its debt held by the public of the U.S. government, and the present value of unfunded entitlements is now 59 trillion (dollars). It was 46 trillion (dollars) four years ago, by the way, when I started in this job. It’s gone up from 46 (trillion dollars) to 59 (trillion dollars); I thought it was a typo, but it’s not. And so every year we grow at 2 percent we just get more leveraged, and so we’ve got to find ways to grow faster. And growing the workforce, finding policies that grow the workforce, improving educational attainment, skills training are essential if we’re going to grow faster.

BUITER: Even with regard to household leverage, it’s only low relative to a crazy benchmark—

KAPLAN: That’s true. That’s true.

BUITER: —of ten years ago.

KAPLAN: That’s true.

BUITER: So one shouldn’t take too much comfort from that.

Having spent some time at the low frequencies and the long run, let me move to high frequencies and short-run phenomenon of some notoriety here. We had a kerfuffle in the repo market, a malfunction, in September. The repo rate overnight went to 10 percent plus. The response to it has, I think, been ad hoc rather than systematic. I would have expected the creation of some kind of repo standby facility. What is your view of the causes of this malfunction? And what is the way to address it in the short run and the medium term?

KAPLAN: So the reason this happened—and this is the first question I get asked. I was joking back there that if I—if I met clergy person that would be the first question they would ask me right now, is what’s going on with the repo—(laughs)—repo. And so here’s what’s—here’s what’s happened.

The Fed was growing its balance sheet up until about a year-and-a-half ago. We halted it, and we started then to run down our balance sheet, OK? In other words, we were saying instead of having a $4 ½ trillion balance sheet maybe the economy doesn’t need us—we’re past the crisis; maybe we don’t need this level of excess reserves. So we started to run down our balance sheet. What did we—and it went fine for a—for a time, until we got to September. And what’s changed? Tax payments are not new, but tax payments in September. What’s new is U.S. government debt issuance is going like this, and the indirect effect of all that debt issuance is it takes reserves out of the system. The other thing that’s happening is because of regulation the big banks, where most of the reserves are concentrated, are not as willing to lend to one another.

And so to your point, we were—we reacted, at least as this happened, we in September—the U.S. lost something like 2(00 billion dollars), 250 billion (dollars) of reserves from September 1 to October 1, OK, because of these trends that I just talked about. So we at the Fed immediately instituted an overnight and term repo facility to sort of step in and smooth these markets. We started increasing our balance sheet by buying 60 billion (dollars) a month of Treasury bills. You mentioned a standing repo facility. I think that’s something, as you may know I’ve said publicly, we should be seriously considering. But I think we’ll get through year end. I’m optimistic we will settle down this volatility. But I think the Fed has learned something, and I think—I think this will be a manageable situation. But we’re going to need to run a little bit bigger balance sheet than we might have thought previously, and the draining of reserves because of these trends that I just talked about is going to be something we’re going to have to manage for the foreseeable future.

BUITER: OK.

KAPLAN: But I agree with you we should be doing it in a—we should—we will get to a point, I’m optimistic, where we have facilities in place so it doesn’t look like we’re reacting; it looks more like we’re proactively managing this.

BUITER: But we should have a peaceful Christmas and New Year.

KAPLAN: We’ll have some volatility in the repo market, but that’s not the end of the world. But yes, we should be able to get through year end.

BUITER: All right. Very good.

When the next cyclical downturn comes—and it will sooner or later; the world is cyclical—the U.S. economy will find itself back at the zero lower bound, without any doubt. A typical peak-to-trough rate cycle pre-great financial crisis was five hundred basis points’ worth of cuts, and we got 150 to 175 to play with. Now, one of the things that strikes me is that many of the colleagues in central bank land have, in response to negative shocks of that kind, have actually gone into negative territory—have gone below the zero lower bound. There’s considerable scope there. I mean, OK, the Japanese are only ten basis points below zero, but the ECB fifty, and some of the smaller European banks have gone to minus-seventy-five basis points. Why has the U.S. not done this? Is there—I can think of obvious technical reasons like you don’t want to embarrass what’s left of the—(inaudible)—money market fund industry.

KAPLAN: Yeah.

BUITER: And there are those who believe that it violates the Constitution because negative interest rates are a tax on bank borrowing from the Fed, and only—and only Congress can tax. That argument makes about as much sense as it sounds, but it has been made. Why has the U.S. not gone negative? Is there an argument for doing so at the next time of asking?

KAPLAN: Yeah, so let me start with what I take as the lessons from Japan, Europe, and negative rates. I think—we’ve studied it very carefully at the Dallas Fed, and I think the lesson for me is I don’t think negative rates—I question whether negative rates have been effective. And I—and I think they do a lot of damage or can do a lot of damage to the health of the financial sector. And in the United States, as you mentioned, we’ve got a big money-market industry and many companies are very dependent on the commercial paper market, which depends on a healthy money-market industry. So the lesson I take from watching these negative rates in Europe is actually we don’t want to do them here, and I think it’s an example—which is a danger right now for us—of central banks trying to do too much.

So what’s an example? In Europe they very much need broader economic policy, and I know there’s been a lot discussed in more fiscal policy from Germany, which hasn’t happened yet.

But I think there’s a danger in the United States. Monetary policy for most of my life has not been the only economic policy in the United States. It just seems that way in the last ten years, but I think that’s a mistake and a trap that I don’t want to see us fall in, in that we need broader economic policy. We need infrastructure spending, early childhood literacy. We need to find ways to grow the workforce. We need other structural reforms away from monetary policy. And where appropriate we need sound fiscal policy, which we’ve used a lot of that capacity, I’m afraid, in the last few years, so we don’t we have a lot of scope for it.

But for me, no, I don’t—I don’t anticipate we’ll be using negative rates in the United States. I don’t think we should. And I think this is one of those times where the central bank, it’s our job to say our role is important but, no, we’re not going to be able to solve this by ourselves, and we need to call out more aggressively the need for broader economic policy. And I think the European case as an example, where I understand why the central bank is doing what it’s doing and there’s no fiscal policy forthcoming, but I’m not at all sure that negative rates are helping. I’m not sure they are. And I, for one, in my seat, I am determined that we’re not going to use those in the United States.

BUITER: Very good.

Another policy that hasn’t been used yet, although it has been used in the—in the distant past, has been foreign exchange market intervention by the U.S.

KAPLAN: Yeah.

BUITER: Right? We at the moment only have tweet versions of that, which do not actually directly or indirectly involve the Fed. Is there a case—I think, say, if there were to be divergent economic developments in the U.S. and abroad—for either a unilateral or possibly a multilateral form of foreign exchange market intervention?

KAPLAN: I think that would be also a fairly dangerous thing. So you haven’t asked about trade yet, but I know we’re going to talk about it. And we talk a lot about trade uncertainty and people always think China. Well, I actually think if it was just China, you know, for most businesses in the United States I think that would be manageable. I think more broader trade uncertainty is what’s been more challenging.

And the reason I mention this is recently—you may remember in the last two weeks—the United States has threatened tariffs against Brazil and Argentina because their currencies are weak. Well, why are their currencies weak? Currencies are weak because the economies are not doing well. And so currencies are a way, when economies are underperforming—the U.K. being an example post-the Brexit vote; their currency depreciated. It’s not manipulation; it’s basically the outgrowth of a weaker economy. Our currency, the dollar, has been stronger mainly because we’ve been outperforming. It’s not necessarily directly a function of where our interests rates are; it’s a function of the strength of the economy.

And so I think this is a dangerous situation where we’ve already got very low global growth, highly correlated with weakening trade. And I would be very nervous about other policies that intervene in this area because I think they may further weaken global growth. And I think while we are more insulated than other countries from weak global growth, it’ll hurt us too. And I’m—at this stage I’m worried about, you know, weak manufacturing in the United States, weak business fixed investment. And weak global growth is feeding into that weakness. And if global growth—I’m hopeful in this next year, by the way, global growth’s going to stabilize somewhat, might even improve a bit. But if it got weaker, I’m pretty concerned that that will spread to other parts of the U.S. economy and we may have more weakening here too.

BUITER: What are the drivers of this slow global growth that you see as a major threat, partly through the trade channel also, to the U.S. continued economic recovery?

KAPLAN: I mean, I will tell you our own view—you know, we’re the—Texas is the largest exporting state in the country, so it’s not surprising we do lots of work on trade at the Dallas Fed. We think probably if you had to correlate why global growth is weak, the number-one driver we do think is trade. If you track what the trend of global trade is versus global growth, it’s a pretty good correlation. So while exports are only 12 or say 13 percent of U.S. GDP, they’re more like 40 percent plus of German GDP. They’re over 20 percent of Asian GDP. So when global—when global trade—when there’s sand in the gears, like there is now, of global trade, U.S. is hurt, but not as badly as countries around the world. So if there’s some stabilization of trade policy and we get some resolution of some of these issues, that’ll probably be the number-one catalyst for improving global growth, in our view.

Obviously, this issue of aging population, most advanced economies around the world have the same problem we do. Germany’s got it worse. Their population aging issue is even worse than ours. Japan’s got it worse. And that’s a big driver of low global growth. And I’d say even though our productivity tends to lag the world growth, you know, productivity growth globally has been surprisingly sluggish—just been more sluggish here. So those are also issues that are going to require structural reforms; i.e., non-monetary policy.

BUITER: Since we are on the international economy, could I tempt you to venturing a forecast about likely future developments of energy prices and the energy sector generally?

KAPLAN: Yeah. Yeah, that’s fair to ask because we’re—we do a lot of work on that, obviously, at the Dallas Fed because we’re—I think if Texas were a(n) independent country I think we’d be the fourth- or fifth-largest energy producer in the world.

So here’s what’s going on in energy. Because global growth is sluggish, this—the energy industry is a great example. For those who say, gee, the U.S. is insulated from slow global growth, I think energy would be an example where that just isn’t true.

And so oil prices are lower. That’s number one.

Number two, it turns out shale is not as easy to make money in as people thought, and there’s a 70 percent decline curve, which means you need to keep drilling and you need more scale, and so that’s been more challenging.

And the other thing that’s happening—two other things. Capital providers—stocks haven’t done well and they haven’t been making money, so people are basically—capital providers are saying I want you now to earn a return; and oh, by the way, if you’re going to spend on CAPEX it needs to come out of cashflow, not out of borrowing.

And then the last trend is ESG. Most pools of money out there are under pressure to be much more sensitive to sustainability. So I have a number of big private-equity firms say to me if we had to raise a fund today I don’t think we could raise a fund. And so this is a capital-starved industry right now.

And how is that manifesting itself? Net production growth in the United States in 2018 was 1.8 million barrels a day, OK? We got up—we grew a lot. This year it’s more like 7(00,000) or 800,000 barrels a day. And we’ve got up to twelve million barrels a day production, so we’re the largest in the world. There’s been a boom. Next year—i.e., 2020—we think production growth will be less than 500,000, and we’re hearing towards zero in 2021 basically because most of the people in the industry just don’t want to spend and their capital providers are putting pressure on them not to spend; in other words, to make higher returns.

And so in the short run we expect energy prices to be volatile, and it’s going to be driven primarily by what’s going on with global growth. If you ask me the price of oil three to five years out—this may surprise you—global growth—global growth is such we still think global demand—daily demand will be a million dollars—million barrels a day plus. It was—1.4, 1.5 million was our estimate about a year ago. It’s slipping down closer to one (million barrels). If it stays in the million barrels a day plus and U.S. production growth is actually, you know, near zero or low hundreds of thousands, there isn’t a lot of new supply around the world. We actually think it’s very possible or even likely in the next three to five years we’ll be an undersupply situation globally and very vulnerable to some type of production shock, you know, geopolitical event. So you could see the price of oil spike. And I’d say in the next three years we’re more vulnerable to upside spike than downside spike, unless global growth just deteriorates much more. But I don’t think—I don’t think that case is as likely.

So I think there’s more risk to the upside on prices on oil than downside, even though people are not investing in the industry. Ironically, I think there’s more upside risk to the price.

BUITER: The Fed raised rates four times in 2018, cut them three times this year. In your view—this is the inevitable question; I just can pop it in before my time is up—what’s the appropriate path of rates going forward?

KAPLAN: I’ve got penciled in no change, so—and I’m not alone, as I’ve read in the newspapers and seen around—(laughter)—in our—in our meetings. So I think the appropriate path of policy is to stay where we are.

We expect, again, 2 percent plus growth, 2 percent growth for next year, unemployment rate around 3 ½ percent. We’ll have some firming in inflation gradually toward 2 percent. And I think with that profile, I think the right—at 1 ½-1 ¾ fed funds rate, I think the right thing for us to do is stay right where we are unless something changes materially on the upside or the downside.

BUITER: On the other policy that I mentioned, balance sheet runoff, is this going to resume? Do you—

KAPLAN: No. Is the balance sheet runoff going to resume? No, it’s not going to resume. I think right now we’re growing the balance sheet. What I’d like to see is after we’ve added—we’ve said we’re going to buy 60 billion (dollars) of bills now for five or six months, which will build up our balance sheet—not to where it was, but it will—it will build. I would prefer to see us have some mechanism in place—and we’ll debate around the committee whether that’s current repo operations or standing repo—that will allow us to have an ample reserves regime but with the smallest possible balance sheet that grows with the economy. But no, the balance sheet from here is, all things being equal, going to be bigger and not smaller. But I’d ideally like to get to the point where the growth comes with the growth in currency and with the economy.

BUITER: Well, I think that exhausts my time. It’s now time to turn to the members. Please join our conversation. Remember, this meeting is on the record and may be audio or video recordings. If you are selected to speak, wait for the microphone and speak directly into it, please. Please stand and state your name and affiliation, and limit yourself to one question if you can.

And we start over there.

Q: Thank you very much. I’m David Braunschvig.

I was wondering if you would consider adding a fifth factor to your explanation of the low inflation, the dramatic change in the market for corporate control. Over the past fifteen years, the percentage of firms owned by private equity owners has risen from 5 to 15 percent. These owners are much more focused on controlling the bottom line than growing the top line, and that has probably a detrimental effect on inflation growth. So the question is—two questions. Do you see that as a major factor? And if so, what is your—what are your policy recommendations?

KAPLAN: So let’s break it out. Let me—let me set aside—well, let me start with there are a number of emerging companies today that are funded by private capital, and you can—Airbnb, Uber, you can go down the list—that are—this is on one part. And then I’ll get to, I think, the other part you’re referring to. But are—a lot of these companies not only don’t make a profit; some of them I’ve looked at their registration statements, they don’t make a gross margin. And in a lot of industries, incumbent businesses are having to compete with them. And so far the financial markets have rewarded gaining share, but that may change as there’s more demand for price discipline. But there’s no question the emergence of these platform companies among a broad range of industries and the market rewarding share over profits, that has actually limited pricing power.

Everywhere else, though, in activism that you’re talking about has led to—private-equity firms tend to buy things with more leverage. They are highly focused on—believe me, if they could raise prices, these companies, they would like to, and they’re encouraging it because they have to deleverage, and they’ve very focused on improving gross margin and improving profitability.

And then the other area where activism is going on is taking—you know, pressuring companies. But most of that is encouraging companies to, again, either do merger activities, get more scale, or do share repurchase to mask some of the margin erosion.

But to your point, where private investing is affected—the thing I’m worried about, you asked about inflation. It’s really for me the first thing, which is the private capital fueling of these platform companies and the markets incentivizing those. I don’t actually think private capital is—I think if anything—I don’t think it’s having an effect on inflation the way you’re describing as much as the first part is. That’s my observation.

Q: Good morning. My name is Nili Gilbert, co-founder and portfolio manager of Matarin Capital. Thanks to you both for being back here with us again today.

My question is about the network for greening the financial system. It was interesting to see the Federal Reserve join this network of global central banks in September that’s focused on the impact of climate risk on the stability of the financial system. Could be insurance companies that have written policies on climate-risky assets or banks that have made similar loans. It was interesting because on the one hand this represents a divergence between kind of headline federal policy and the risks that the central bank is considering. I was wondering if you could tell us a little bit about how this affects you as the head of a regional bank, especially Dallas with so much energy sector in your region. And also, do you have any perspective on this from your role as the former head of investment banking at Goldman? Thank you.

KAPLAN: Yeah. So let me—let me start with—so I’ll direct your attention, look at our site. We just—we just wrote a lengthy essay on climate change I guess it was two, three months ago, and you might look at it. And what we went through—so there’s a number of aspects to climate change.

What the Bank of England and the work we’re doing broadly at the Fed—we’re starting to do—is about financial stability, as you said. So that’s one part of it. And I think we’ll continue to do more work on that.

The part I’m particularly interested in—and we’ve done an enormous amount of work in the Eleventh District on—is the impact economically of climate change. And it’s already having a significant effect on our district. And what do I mean by that? Hurricanes. And our—and we did a lengthy analysis, which you may look at it, of the National Climate Assessment, and if it’s even close to being correct we think the frequency and intensity of hurricanes is going to increase—a hurricane being seventy-four miles an hour or greater, you know, storm. And Harvey alone is estimated to have cost about $80 billion. And if those, you know, thousand-year events start happening with great frequency, which we think they’re going to happen more often, that has a big economic effect.

And in addition, in Texas along the Gulf, we house a good bulk of the nation’s petrochemical and refinery infrastructure. We have key ports along the Gulf that we think need substantial—billions of dollars in refurbishment and investment. And in the next hurricane, if we don’t make those investments, our concern is—and people who run the ports, their concern is—it’s going to impede global trade for the whole country.

In addition, we have droughts, floods, you’ve got the fires in California, so what we did is do actually an analysis of how that’s affecting the Eleventh District and the country. We’re also working with the San Francisco Fed, who is also obviously affected by this, and obviously the Atlanta Fed because of, you know, hurricanes in Florida—is very affected.

So there’s not only the financial stability issues, but I think that’s more conventional and you’ll see us do more work. I’d like this—we’re doing more work on just understanding what’s the migration impact, the economic impact, what are the investments that need to make. There’s not a week that goes by I don’t talk to a mayor or a leader somewhere in the state that isn’t actively thinking about making multi-billion-dollar investments either in building the reservoirs along Houston, or along the port, or protecting infrastructure, who isn’t worried about this—plus agricultural impacts and everything else. We think this will increasingly start to manifest itself in affecting GDP, and so that’s a lot of the work that we’re doing on it.

BUITER: Question here.

Q: My name is Hariharan. I’m from NWI Management in New York.

Robert, you made it clear that you don’t like negative interest rates. You also made it clear that you are not a fan of dollar intervention. But there are two important trends outside America right now. You have a lot of the developed world—Japan, Europe, everybody in deep negative rates.

You also have a situation in the emerging markets where currency depreciation is not passing through inflation to the economy. So there’s a motivation for every emerging market now to cut rates and, if necessary, weaken the currency.

Here’s the question. By definition, the dollar is now on the other side of this equation, tightening monetary policy in a manner outside your control. Does it mean your ability to do anything on rates now is all to the downside; meaning you have no ability to raise rates because of this global phenomenon, and the path of rates here is here or lower?

KAPLAN: Yeah, so I don’t think that—that wouldn’t be the conclusion I would draw. What I am concerned about is—and again, this gets back to, it strikes me, there’s been—this isn’t true in Asia, but in the rest of the world, again, the primary economic policy has been monetary, OK? And I think by what you are saying—which I agree with—it’s not going that well. We need broader economic policy that is going to, you know, build infrastructure, improve educational attainment, improve productivity, and the other thing is I think some of these issues you are talking about are a symptom of, I would call it, deglobalization. In other words, if we’re going—if we’re going away from integrating with the rest of the world to deglobalizing, I think you are going to see some difficult economic outcomes as a result of it.

And so I—for me, it doesn’t mean that the Federal Reserve won’t be able to do what it needs to do on monetary policy, but it does mean that unless we address some of these issues, global growth is going to be disappointing. And if global growth is disappointing, it means—at a time where potential growth in United States, I think, is also deteriorating—if we don’t address these issues, I think there were places in the world where there are bright spots for global growth—they have better demographics, they have emerging middle classes—but if we have some of these structural issues, I don’t think we’re going to realize those benefits and, I think, the path therefore of growth here in the U.S. is going to be lower rather than higher is my concern.

And so this is why, when we go around, we talk more broadly than just monetary policy because I think we’re going—there’s going to be a bunch of policy issues that, if we don’t like some of these outcomes, it’s going to have to be about more than just the Fed.

BUITER: Question over there.

KAPLAN: And we should make sure to get Byron—

BUITER: Yeah, I’ll get him next.

KAPLAN: —who just announced his ten big surprises.

BUITER: (Laughs.)

Q: I’m looking forward to his surprises as well. So Andres Small, Partners Group.

I was surprised to hear—if I heard you correctly—that productivity and/or literacy in the state of Texas lags the U.S., lags the world.

KAPLAN: Yeah. Well, literacy does. Productivity, we’re still doing well, but there are some reasons for that. We have substantial migration to the state, and my concern about literacy is that our future workforce in the state of Texas, particularly if migration stabilizes, those young people are the future workforce. And if literacy doesn’t improve, our productivity is going to be sluggish.

Q: So my question is, despite energy trends being negative—

KAPLAN: Yeah.

Q: —negative weather events, adverse immigration policies, Texas is a brighter spot than looking at other—

KAPLAN: It is, and I can explain why.

Q: Please. And are the beggar-thy-neighbor policies, that if they were replicated by other states, you would go spiraling downwards?

KAPLAN: So there’s a lot of—the positive trends going on in Texas; first of all, energy, even though it’s challenging right now, is around 8 percent of the state’s GDP, so over the last thirty years Texas has become dramatically more diversified. We have a big tech sector and we have—and the big thing we have is substantial migration of people and firms to the state. And so the population of Texas ten years ago was around twenty-two million; we’re on our way to twenty-nine million, and it’s our own estimate—the Dallas Fed—over the next twenty-five years, we may well get to forty million, believe it or not. Yes.

And by the way, I’m from the state of Kansas. Let me give you the Kansas trends over that period: 2.93 (million), 2.93 (million)—flat. And by the way, thirty-five to forty states in this country—Illinois, others—population trends are flat to down. And so what’s the most valuable thing you can have as a city or a state is a growing population and growing workforce growth. That is critical. And then, obviously, you want to make sure they are highly educated, they’re in good health, and they are employable, and they are productive.

Texas has almost all of those. You can check almost all those boxes. Migration, to some extent, has masked some of the issues about early childhood literacy, and we’ve come together in the state—we’re part of a group with business leaders, the governor, and others to try to do—we just passed education reform in the state of Texas—$5 billion—to invest in early childhood literacy and improving educational attainment so we can address this.

But what’s the lesson for the country? The problem for the rest of the country is population trends are flat to down. We are not—we are not doing things in the country to grow population. And I know, for example, immigration is a very sensitive—it goes without saying it’s a very sensitive issue. We do a lot of work on it in the state in our bank. We think the U.S. immigration system should be restructured to be more skills-based and employer-based—much more like Canada.

But I would also say if you think you’re going to cut immigration in the United States and you are going to grow GDP, those two things don’t go together. The reason Texas is outperforming—one of the big reasons is population growth and migration. And so it makes me feel Texas is going to outperform the country, but it also makes me worry about the rest of the country because the population trends are flat to down. And we can address it, but we’ve got to have policies that address it—or we need to get a lot more productive to offset that slowing population growth. And we’re not investing enough in education yet—I hope we will—to offset this slowing population growth.

BUITER: Yes, indeed.

Q: Byron Wien, Blackstone.

Rob, in the year 2000, the accumulated debt of the United States was $6 trillion and the blended interest—government interest rate on it then was 6 percent, so debt service was 360 (billion dollars). Today the debt is around $22 trillion, the blended interest rate is a little over 2 (percent). The debt service is 450.

Now can you explain to me how the debt could quadruple—

KAPLAN: Yeah.

Q: —and the interest rate could go down by two-thirds?

KAPLAN: Yeah, so let me—let me—actually, that’s—let me—let me give that a shot.

So there’s two things going on. Number one, global growth since 2000 and the prospects for global growth have deteriorated pretty substantially. Population demographics have deteriorated, and instead of growing at, you know—hopefully to grow at 3 or 4 percent, we’re growing—I think potential GDP growth in the United States is 1 ¾ to 2 (percent), OK?

And so what’s the number one driver, in my view, of interest rates along the curve? Prospects for future growth, and I can tell you—look, global liquidity is part of it, and there’s been lots of central bank—you know, central bank balance sheets have gone from 4 ½ trillion (dollars) to 25 trillion (dollars), so that’s a part of it. But I think the bigger part is prospects for future growth have deteriorated substantially so interest rates are lower. That’s number one.

Number two for the United States—we’ve got the ability to print money, and the dollar is the world’s reserve currency. And my concern is, if for the rest of our lives—or beyond our lives, our kids’ lives—the dollar remains the world’s reserve currency, we’ve got a unique ability—unlike other countries—to finance this growing debt. But I think it’s dangerous to assume that the dollar is always going to be the world’s reserve currency. And it’s not that the world needs to stop buying dollar-denominated debt; they just need to reduce their overweight. And so a hundred basis points on that $22 trillion is a lot of money, and I’m worried—with technology, digitization, digital currencies, other developments we can’t even envision today—if that ever changes.

We do a lot of work at the Dallas Fed. We’ve analyzed—you’re not surprised—every country in the world, what their fiscal situation is, what their rules are, and how they’re dealing with it. And the one thing that jumps out to you, there’s only one country in the world that’s not following—you know, there’s rules—countries—about how much excess reserve, foreign reserves they keep, excess reserves they keep depending on—they try to limit their amount of foreign debt, and they try to watch their fiscal situation. The only country in the world that’s really not paying attention to those rules is us, and the reason we’re doing it is because we’re the world reserve currency, but we’re relying awfully heavily on it, and I’m concerned whether it’s—I think it’s dangerous to rely on that for the rest of—indefinitely. I’d rather see us find ways to grow faster, and obviously we’re going to have to look at entitlements and other ways to moderate this debt growth.

And the reason I keep talking about these issues, every issue we’re debating—policy issue—is a different debate when you do it in the context of how leveraged we are. The immigration debate, in isolation, is one debate, and then when you put it in context of the need to grow and how leveraged we are, you might have a different discussion. And so we just like to see these issues all get put on the table and debated.

Obviously, as a central banker, we only have purview over certain elements of it, but I am allowed to call out these issues, and that’s why we do it. We’re worried about this.

BUITER: Question over there, the young lady.

Q: Robyn Meredith from BNY Mellon.

I wanted to go back to the laundry list of things you’ve named as going wrong in the country. You know, we have this kind of tale of two labor forces—

KAPLAN: Or I call them opportunities.

Q: Opportunities for improvement, sure.

KAPLAN: Yeah, how’s that?

Q: OK, that sounds better—but all as sort of the world going the wrong way on globalization, going the wrong way on productivity growth, et cetera.

It seems to me that all of the things that are opportunities for improvement are—until they’re improved, really widening income inequality—

KAPLAN: Yes.

Q: —and that has an effect on—so first I’d like you to talk about that. And then that really increases the partisanship that we have now. You’ve talked repeatedly—as has Christine Lagarde and others—about the need for the world not to just rely on monetary policy to solve problems.

KAPLAN: Right.

Q: But given the realpolitik that right now there is a lot of partisanship, both in Washington and in the states, that seems kind of unlikely. So are there some contingency plans because it seems like if we rely on monetary policy—

KAPLAN: Right.

Q: —it will be something along the lines we’ve seen before, so we’re going to see a further exacerbation in income inequality.

KAPLAN: So if we don’t, it is—I think it is true. If we don’t improve education, early childhood literacy, more skills training, I do think—I’m concerned that income and wealth inequality will grow.

I’ve been encouraged and heartened in the state I live in. I’m pretty optimistic. A lot of these changes need to be made locally; in other words, in cities and in the state. Skills training would be a great example. Worker mobility is historically low, but I see Dallas Community College, El Paso Community College, Greater Houston Partnership—they go out and interview businesses, they backward integrate into curriculum either at high schools or at junior colleges, and we are creating lots more skills training in the state of Texas. So I’m optimistic it can be done.

We’re expanding pre-K in the state of Texas—takes money and improving teacher pay. These things are not overnight or magic bullets; they take—they’re going to take years. But I think we talk about them a lot at the Fed because if you—to me, the number one, at the top of the list ways to address inequality is improve education—the whole ecosystem needs to be dramatically improved.

And I think—without it, I think there will likely to be more backlash because more people are going to see—again, like I talked—their jobs getting restructured and eliminated. I’ve got to tell you, technology, technology-enabled disruption—this trend is going like this. The improvement in education and skills training is improving like this. Businesses—I have no worries about businesses adapting to this trend; they’re doing just fine—extremely rational, very astute. But the problem is the impact on the workforce is substantial, and I think we need a lot more focus on and much more dramatic improvement in education, educational attainment.

You know, I think the last thing I—study I looked at, we’re twenty-fifth out of thirty-five industrialized nations in math, science, and reading. When did that happen? I mean, we lag.

Canada, by the way, in literacy, is in the top two or three. Canada ranks very highly. We can get a lot better, and every job that goes unfilled—skilled job, which we think there are over a million skilled jobs that are unfilled, there’s just lower GDP in the United States, so those are things we can do.

I think infrastructure spending also would be helpful. A lot of it can come from private money. But yes, I’m cognizant of the fact these are not monetary policy issues, but we can talk about them, and I think part of my job—you know, I didn’t leave the private sector to keep quiet—(laughs). Part of my job is to do monetary policy, and we’ve got a big research machine at the Fed. We do high-quality work, and we do it in an apolitical way. And my job is to disseminate it, both sides of the aisle, to elected and appointed officials.

BUITER: We have a basic skills problem. I mean, U.S. PISA scores continue to be underwhelming indeed.

Other questions? The gentleman that’s over there.

KAPLAN: There’s enough centers of excellence, though, in the United States that are doing this well, I think we can—we could do it. But it’s just going to take a lot more discussion of it and a lot more, you know, push.

Q: Josh Lynn from Caspian Capital.

I’m just kind of curious—your work or your team’s work on energy—

KAPLAN: Yeah.

Q: —in two ways. One, the transmission mechanism from the energy sector to the broader economy in the context of more aggressive carbon policy, so the puts and takes, the positives obviously being maybe cheaper carbon, innovation—

KAPLAN: Yeah.

Q: —the negatives being we make a lot of stuff to send to energy companies, and energy companies are big.

KAPLAN: Yeah.

BUITER: And then, two, on more of a micro level, whether you guys have done any work on the extent to which regulatory forbearance over the last three years under the new, you know, federal policy regime, post-Obama—

KAPLAN: Yeah.

Q: —has maybe masked even more difficult problems within the energy sector at the firm level, just given, you know, what our pretty negative returns on invested capital despite a somewhat easier time to be an energy company today than three years ago. So just kind of curious on the macro and the micro level on that.

KAPLAN: So here’s what I’d say. As long as global—let’s get to the bottom line. Yeah, regulatory forbearance has been helpful and it’s welcome to—not only in this industry but other industries. But if global growth is going to be sluggish, this industry is going to have—is going to have challenges; i.e., I would guess—just to get to the punchline—somewhat higher price of oil is not going to spur more production or CAPEX because of the trauma this industry has been through. I think you’re going to need to see a $10-plus—what I hear from contacts—meaningful increase in the price of oil before people decide they’re going to try to spend more on CAPEX. That could change, obviously, and sentiment could change.

I think the irony is—so our work on climate change and sustainability, a lot of these energy companies and suppliers to them are working on this. But the other irony is we think a huge business opportunity in the United States is sustainability. We have many of the leading companies in the world. We could develop many of the leading companies in the world. Yes, would it have some effect on some of these energy companies? It might. But our own estimate is even if we had aggressive growth in alternatives, in the United States and globally—and I mean aggressive—we still think by 2040 over 70 percent of global energy consumption is going to be fossil-fuel related. So the energy business is going to be here for a long—the fossil-fuel business is going to be here for a long time. But we think there is an enormous business opportunity in sustainability, and I mean profit-making, CAPEX-oriented opportunity.

Last comment: Because energy is a pretty big part of business fixed investment in the United States, if energy investment turns out to be down 15 percent next year, it’s going to be hard for business fixed investment to be a positive number next year in the United States.

BUITER: Next one over there.

Q: Stephen Blank.

Throughout this morning you have pushed—you have talked about the need for more pushful, more aggressive policies, whether it’s education, whether it is sustainability, and so on. Are you optimistic that in the next years we are likely to see a national government that will deliver these more pushful policies in these very necessary areas?

KAPLAN: I’m careful not to comment on that, and I don’t know is the honest answer anyhow. I would say I am optimistic that locally—in cities and in states—there’s enormous motivation to improve in these areas. The problem is you have to go then state by state. Where are they going to fund it?

I know where Texas is going to fund it. We have population growth and we’ve got plenty of money to fund it. If we don’t do it, it will be because of choices we made.

There are a lot of other states whose populations are flat to down. Their state pension funds are underfunded, and they’re getting squeezed, and they can’t, you know, raise taxes to generate revenue. And so they’re having to make some tough choices about how they fund these priorities.

So in that context, yes, I’m worried about education not getting enough funding, not because people don’t want to but because they are trying to struggle with how to fund it. And it may be—and I say this as a businessperson—I say this to businesspeople everywhere I go, particularly in Texas, but all over—it probably is going to require businesses maybe to step up more and maybe play roles that we haven’t historically to help fund and encourage—and skills training would be the top of the list. Businesses naturally are already funding skills training. I think we may have to do it more and go partners with state development—you know, workforce commissions, and get these projects funded. And I think many businesses I talk to are very willing and motivated to do it. And so we may have to see more of that.

BUITER: OK, last question.

Q: Hi, I’m Joyce Chang from JPMorgan.

I want to bring the conversation back to the monetary policy framework.

KAPLAN: Yes. Yes.

Q: And so with all of these forces of deglobalization, slower growth—

KAPLAN: Yeah.

Q: — muted inflation, at the Fed’s policy review, would you consider moving towards a more flexible inflation averaging? How can you encourage an overshoot on inflation?

KAPLAN: So I’ll make a couple comments on this, and just for those—we’re going under—we’re undergoing a year-long policy review. We probably won’t finish it until the middle of next year.

Regarding inflation, my own view is—so we do an averaging—we have an averaging of inflation right now; it just happens to be twelve months. It’s the twelve-month PCE. Would I be averse to seeing that averaging period lengthened so that we take into account underages with overages? No, I’d be fine with that. The only thing I don’t want to do in our framework is make commitments based on that analytic about what actions we’re going to take. In other words, I think we should find new and different ways to look at inflation. We should make clear—and I would say publicly we should be willing to tolerate some overshoot of inflation as long as it’s not persistent—you know, for some temporary period of time.

But on the other hand, willingness to do that, I think when you get into a situation, you need to have the ability around the FOMC able to make decisions and use our judgment. And I wouldn’t be committing to what actions we’re going to take. But I think you will see us talk a little bit differently about our inflation.

I think the other thing you will see us talk more explicitly about it financial stability. We are also very aware—yes, we’re running a hotter labor force; I think there’s a number of benefits that could come from getting people into the workforce and having them stay in the workforce, but also that creates excesses and imbalances that we have to watch in terms of financial markets and other excesses, and I think you’ll see us in the framework—I would like to see us more explicitly note that as one of our explicit considerations as we weigh off these options.

BUITER: OK. It’s left to me to thank Robert Kaplan—

KAPLAN: Thank you, Willem.

BUITER: —for a very stimulating Q&A session. (Applause.)

KAPLAN: Thank you, Willem.

BUITER: Thank you.

(END)

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