A Conversation With Robert Kaplan

Wednesday, May 31, 2017
Kevin Lamarque/Reuters
Robert S. Kaplan

President and Chief Executive Officer, Federal Reserve Bank of Dallas

Tom Keene

Editor-at-Large, Bloomberg News

Robert Kaplan discusses the importance of fiscal policy and structural reform, how changes in energy markets and in demographics are affecting Texas, and the slow growth challenges facing the U.S. and global economies.

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.

KEENE: So let us begin. This is—it seems always at the Council on Foreign Relations exceptionally timed, not only within the politics of the nation but within our economics. Let me go through the obligatory notes. This is the C. Peter McColough Series. And we do this today with Robert S. Kaplan, who will always be for me of Harvard and I believe of a small Wall Street firm, but now is affiliated with the Dallas Fed. This is the series on international economics, and it is international in that so much of our monetary economics today is linked.

We’ll go about a half an hour and then your question, please no lectures. No follow-up question. I don’t know how to do them. I’ve never developed the presidential skill of follow-up questions, but your good questions. This is an on-the-record session. That’s always a good thing. And as members, we look forward to your questions. You’ll have a microphone, which we need because CFR’s streaming this worldwide, as well as other media groups, including Bloomberg Radio and Bloomberg Television. And we thank Ted Fine and our team for putting that together today.

Yes. It says here please limit yourself to one question because the moderator can’t remember the second one. And of course, keep it concise so he can get in as much as we can. We’ve got a hard out at 9:00 a.m. because of the president’s schedule. This is a joy—I should point out the celebration of the Council on Foreign Relations new website. It is the definitive vehicle for international relations. And of course, I keep telling Ambassador Haass, put in more economics, put in more economics. And so I guess today we have a double celebration of the website of the Council on Foreign Relations, but also the heritage of your venue.

The Dallas—all the Feds are different. And the Dallas Fed is different. The view from—is twenty-two-hundred or two-thousand-two-hundred North Pearl Street? What do they say? Twenty-two-hundred? I think that’s the Texas way.

KAPLAN: I had not thought about it. Yeah, 2200 sounds good to me, yeah.

KEENE: The view is different. And it may be the Georgia School and it may be the legacy of McTeer, and of course the relationship with our nation (to the south ?), but there’s a heritage about the Dallas Fed that is different.

And so with that I’m not going to go through your bio, because it will just take too long, other than to say he was Marshall Professor at Harvard Business School by way of the University of Kansas, which is always a good thing. What have you learned about the heritage of the Dallas Fed, parachuting in?

KAPLAN: Well, there’s a great history in the Dallas Fed, but what—the most significant thing to me about the 11th District is the business dynamics. It’s the largest energy producer in the United States, largest exporting state—Texas is—in the United States. Growing very rapidly.

KEENE: Maybe the president will go after you after he’s gone after the Germans.

KAPLAN: Well, I won’t even go near that. (Laughter.) But—(laughs)—and we’re growing very, very rapidly. We’re—the migration of people and firms to the state of Texas in particular has been a significant trend that is accelerating over the last 15 years.

KEENE: We have a national growth rate, 2, 3 percent, whatever it is. What’s the Texas growth rate, if we’re at 2, 3 percent?

KAPLAN: We’re growing about a full percentage point faster over the last 15 years on average every year. And so what it’s going to be this year, I’m not sure. But for lots of reasons, people and firms are moving to the 11th District. So we’re growing very rapidly.

KEENE: And that’ll be one of our themes here, particularly to dive into the concept of John Edwards’ two Americas. And maybe we can talk, not—your district’s outside Texas, but the two Texas’ is a more general statement. I want to go to an idea that I was talking with our Matt Boesler about. And this is this wonderful thing. This is a mouthful, folks. For those of you not in economics, this is why you’re not in economics. The Dallas Fed trimmed mean PCE. That’s your proprietary view of inflation. What I know in my work in Bloomberg is inflation and the vector of it now is front and center. Is the vector up or is the vector to disinflation again?

KAPLAN: So it’s been weak the last couple of months. If you go step a little further back, it’s been gradually increasing from 14, 15 to 16, now to 17. The thing that’s giving people pause is over the last two months, particularly March, for a number of I think idiosyncratic reasons, inflation dipped. Telecommunication pricing, other factors. But you notice the PCE came out—personal consumption expenditures came out yesterday. And I think it showed me that the April number is sort of back on trend. The number—most people quote the trailing 12 months. And you’ll notice the trailing 12 months after yesterday declined. But the reason for that is not that April was weak. It was that a year ago April was so strong. So I actually think while inflation has been slow and uneven, I don’t think we have a deteriorating trend. I don’t believe that’s what’s going on.

KEENE: Two tacks off this. One is the Dallas heritage. I’ll get to it in a moment. But let’s talk about the more Washington-centric analysis, and we heard that from Governor Brainard earlier today, and all the other Fed speakers all diving into this mix. Is your take that the prism around that table at the Eccles Building—is your take that it’s a traditional study of inflation, or is there a new new to how the Fed itself has to deal with this odd thing?

KAPLAN: There’s definitely, in my judgement, a new new. Now, I’m not an economist. I’m a business person. But I have—I work with lots of economists. So I think that gives me a little different perspective, that the things that are new—I’ll mention two in particular: global overcapacity, particularly because of China. China has been growing GDP on average of about 6 ½ percent a year. But the problem is it’s—they’re increasing debt to GDP in order to achieve that growth, and they’re creating overcapacity not just infrastructure, but in industries like steel. So that’s increasing global overcapacity. That’s creating a headwind for inflation.

And then the second thing that’s significant is technology-enabled disruption, which is another way of saying machines are increasingly replacing people, but consumers can use technology now to shop for pricing more than ever in our lifetime. And therefore, the pricing power of businesses is less than it has been at any time in our—

KEENE: Do the Ph.D. economists in Washington know that? I mean, a guy like you comes from a different world. The guy up in Minneapolis comes from—Kashkari comes from a different world, et cetera. Do you guys have an advantage because you didn’t read the textbooks?

KAPLAN: Well, I think many of the—many Fed presidents, I would say even most, do what I do. I talk to all the economists. I go through all the economic theory, all the economic data. And then I talk to probably 30 CEOs every month. We do surveys among businesses—small businesses, big businesses. We do not only industrial surveys but energy surveys, service-sector surveys. And I put them both together. So a lot of my understanding about what’s going on out there, I look at data, but a lot of it also comes from talking to business leaders.

KEENE: Talking to business leaders is in the present. What are your thoughts on forward guidance, this concept, this silliness of data dependency? Do you find the dots to be a constructive tool?

KAPLAN: Well, so, there’s a few questions in there. So let’s talk about data—let’s take data dependency for starters. So I’m not—I’m not crazy about the term data dependency. I’d prefer to look at data, that as a businessperson, again, I like to look at secular drivers. And then data, as the economy unfolds, either confirms or makes me question the effect these drivers are having. So, for example, GDP growth is sluggish. I think the big driver behind that—one of the big drivers is aging demographics, slowing population growth, slowing workforce growth. And so that makes—that makes sense to me. So I think you got to look at both. But I prefer to look at drivers, and then the data sort of confirms—like I would as a businessperson—what track we’re on, or whether the drivers are having the effect I think.

KEENE: Let’s go two hours. This is going too well.

KAPLAN: All right. So you talked about the dot plot.

KEENE: The dot plot.

KAPLAN: So let me explain to people—I think most people probably know—

KEENE: Come on, we all know what the dot plot is.

KAPLAN: Well, shockingly, some people may not know what the dot plot is. But every quarter, all the Fed presidents and the governors submit—we all submit our forecasts for ’17, ’18, ’19, and the medium term, GDP, inflation, not only headline but core, unemployment rate, and what we think the neutral rate is likely to be, which we’ll come back to, settle out. So that’s referred to affectionately, or not so affectionately, as the dot plot, or the summary of economic projections. But that gives you a pretty good feel every quarter of what each of us is thinking about. And the views there—there’s a scatter chart, but they tend to congeal around certain medians.

KEENE: Where’s the vector of that chart right now? What are we going to see in the future dot? I mean, you—I know you’re feeling your form out on the way from Reagan into the Eccles Building.

KAPLAN: Right, naturally.

KEENE: But, I mean, come on, there’s a lot of analysis going into this thing, but is it a valuable tool and what’s it going to show us in a number of months?

KAPLAN: Sure. A somebody who’s been observing the Fed now for 30 years—that’s me, in my business career—I think it’s very useful, because it gives me a pretty good idea about what every participant around that table is thinking. And when there are differences, it gives us a basis to debate. So I think it’s very useful. My own view, just my dot, has been GDP growth, for example, this year would be between 2, 2 ¼ percent. I think the unemployment rate’s 4.4 percent now. I think it’s going to decline further as we get into the end of this year. It’s not the only employment measure I look at. I look at something called U-6, which doesn’t go in the dot plot, which I’ll come back to. And my own view is inflation will slowly, but gradually, over the next two or three years—not immediately, but over the next two or three years—get to 2 percent.

KEENE: Within your wonderful books on leadership, there is implied through all these books confidence. One of the great mysteries in this room at the Council on Foreign Relations, one of the great mysteries in your Dallas district, is where is business investment, where is the confidence to move forward? Let me just start with the math in this. Is it because the people that you used to talk to at HBS, they can’t figure out where the risk-free rate is? Are the distortions so great?

KAPLAN: So let’s take—let’s take the first part. Business confidence right now is high, OK? There’s a lot of business optimism. And you see business investment is stronger this year than it’s been in the last few years. The issue is that’s great and it can help GDP growth, but 70 percent approximately—65, 70 percent of the economy is the consumer. So at the end of the day, businesses are more optimistic for several reasons. But ultimately, everyone is watching the consumer. The consumer is the primary driver of GDP growth. Increased business investment though helps. And businesses right now are optimistic. Do they see it? The disconnect right now is while they’re more optimistic, then when you ask a business leader, do you see improvement in your business? Oftentimes the answer is not yet, but we’re expecting it.

KEENE: We’re expecting it.


KEENE: We’re still there. Does that have to do with Reinhart-Rogoff length or duration coming out of the financial crisis, it just takes time to heal? Or is there a new format of globalization where American business is waiting to pull the trigger on the nostalgic investment we remember?

KAPLAN: So, for me, I think some business leaders are hopeful that fiscal and other policies might help improve GDP growth. That’s part of it. And in addition, though, some of the things that have been headwinds which I don’t think are going away—sluggish population growth, which has a big impact on consumer spending, and sluggish GDP growth, but also increasing disruption and new business models increasingly are displacing old ones, which are giving many business leaders pause. Even though they want to invest in their business, they’re not sure that the model that they’re investing in is going to be sustainable. So I think that’s a—that’s a countervailing headwind which is putting a bit of—tamping down a little bit of the optimism.

KEENE: Right. So you wander down to College Station and you have to give a lecture at the business school, and some wise guy in an Acore (ph) uniform stands up in the back and goes: Excuse me, sir, do you believe in GDP, because that’s a whole belief right now, that these statistics, these traditional models that we have don’t work anymore. How do you respond to the youngster at Texas A&M?

KAPLAN: Yeah. So here’s the things that are clear and here are the things that are getting debated. GDP growth is still—it’s not perfect, but it’s still a pretty good measure of economic activity. There’s an issue a lot of people raise about transfer pricing. You know, Apple innovates a phone here, but they manufacture it overseas. But I still think GDP growth is a pretty good measure. The debate has been about the unemployment rate. And famously, you know, many people have gone on television and said the 4.4 percent, that’s a great number, but it’s not a real number. So I like to go to U-6, which I mentioned earlier. Here’s what U-6 is, in the lingo.

So U-3, to use the lingo, is the headline unemployment rate. U-6 is unemployed, plus discouraged workers, plus people who are working part time if in a better economy would rather work full time. I think that’s a better measure of slack. That’s at 8.6 percent right now. Here’s the problem, the prerecession low in that number was 8.1 percent. So we’re gradually moving toward the prerecession low. And in a 160 million-person economy, the difference between 8.6 and 8.1 (percent), it’s less than a million workers. While there’s slack, there’s not as much slack as people might think.

And here’s the second problem, which we’ll get to. Where there is slack, it is highly correlated to lower levels of educational attainment—i.e., college and less than college. That participation rates and employment rates, if you finish college, are very high in the United States. They can get better, but they’re pretty high. Even if you’ve finished some college, they’re relatively high. If you went to high school, though, they’re lower. And if you got some high school education, they’re much lower. And so the problem is where there’s slack and discouraged workers, there’s a high correlation between high school and less than high school. And that’s why there’s a number of things we’re going to need to do to address that.

KEENE: I want to ask one more monetary question before we dive into some of the research you and your team have been doing at Dallas. One of my treasured books is out of the Dallas Fed. And it is a beautiful, thick monograph, exceptionally smart set of essays, in honor of John B. Taylor of Stanford University. It was a symposium that was done there. I’ve read the whole thing cover to cover. It is—math warning, you know, for those of you at the CFR, I’m sorry, algebra, differential equations. But within that is some brilliance. Do you buy the traditional economics of the Fed? When the media trots out the Phillips curve and you—and I could go much deeper than the—(inaudible)—answers—do you buy the orthodoxy still works? Or do we have to amend it?

KAPLAN: So let me talk about some things that have been used historically that I think need to be adjusted. The Phillips curve for example, which talks about transmission. If you’re at full employment, you would expect wage pressure. You would expect that wage pressure to translate into price pressure and inflation. I would say because of globalization—i.e., this excess capacity issue—and also what I talked about, disruption, the fact that businesses have less pricing power, I think the Phillips curve is still—is alive and well, but it’s more muted. Meaning, to the extent there’s wage pressure today, it’s less likely to get transmitted to prices, because customers won’t accept the price increase. And because businesses can replace workers with technology when there’s wage pressure, it puts some downward pressure on wage pressure. So that’s one example.

I would say the second thing is the economy is dramatically different than it was 10 years ago, 20 years ago, and 30 years ago. You know, a lot of people like to refer back to the Reagan era, and it’s—here’s what’s so different. Aging demographics—so the trend over the last 30 years has been going like this, slowing population growth, lower participation rates. And over the next 10 years, the bad news it’s going to get worse. And it’s one of the few things we can forecast with a lot of confidence. And we think the participation rate today is 63 percent. It’s likely to dip below 61 percent. So that’s one issue.

Globalization is different today than it was 20 or 30 years ago, meaning we’re much more globally intertwined. But the trade relationships I think are being misdiagnosed a little bit today, meaning it’s not a zero-sum game. Our relationship, for example, with Mexico, in our judgement, increases U.S. competitiveness, has caused jobs to stay in the United States that we’d otherwise lose most likely to Asia. And so you have to think about globalization differently. Disruption we’ve already mentioned. Then I got one last one and then I’ll stop.

And that is the debt super-cycle. We are much more leveraged today than we were 10 years ago, certainly 20 years ago and 30 years ago. Government debt held by the public is now 76 percent. It’s been going up. And present value of unfunded entitlements is now $46 trillion, also been going up. And become of aging demographics, makes it worse. And it’s that last part I think that creates a headwind that isn’t talked about that much. The reason it’s not talked about is rates are so low. If you had more normal interest rates, I think we’d be having a much more intense national discussion on this.

KEENE: I want to take the sum of those themes. But I got to rip up—

KAPLAN: So it changes everything. The Fed analysis, you want to talk about the Fed model.

KEENE: I agree, it changes the Fed model.

KAPLAN: The world’s different. So we’ve got to change the way we look at the world.

KEENE: OK. We’re going to do that in a minute. But I’m going to rip up the script on one question. I want you to speak not so much to the president as a public official—I know you’re not going to take shots at any other public official.

KAPLAN: No, I am not.

KEENE: I know you’re not. We’re going to get that out of the way. But what I would suggest within the format of the Council on Foreign Relations and the heritage of this shop, we can go back to Jacob Viner’s Chicago 1948 and talk about America as a mercantilist power. You’re on the border with Mexico. They’re going to build a wall. You can see it outside your window on Pearl Street. Are we going to end up being a mercantilist America? Is that a real risk?

KAPLAN: It’s a direction we would be well-served not to go in. And here’s the problem, is 40 percent of the imports from Mexico today is U.S. content, OK? Means these goods go back and forth across the border. Adding jobs in the U.S. is not the only criteria. Are they globally competitive? Will they sustain? Will they be here 10 years from now? The relationship with Mexico allows us to be more globally competitive. Here’s the second problem, is geopolitically I think this country—maybe we’ve taken it for granted—is very well-served by having stable relationship with—a stable relationship with our neighbor on our southern border. It has been—it’s very helpful to the United States.

So my only—my main concern—I think NAFTA—my own view, and I’ve said this publicly—will get renegotiated in a constructive way, despite the rhetoric. But the mood in Mexico is much more—and I go down there a lot and spend a lot more time with leaders there—is more anti-American. And my concern is when there’s a presidential election in Mexico in the summer of 2018, unless we—unless we can improve this tone, it’s more likely that you’ll have to be anti-American to get elected as the president of Mexico in the summer of 2018. I think that would—that would not serve the United States very well.

KEENE: Let us coalesce together—before we get your questions here in about 12 minutes—I want to coalesce together some of the themes you and your researchers have been working on. I go back and forth with Michael Dell, who’s a leading technologist in your shop. Arguably he jumpstarted—I mean, I think asleep—

KAPLAN: Austin, Texas.

KEENE: —the band asleep at the wheel would think they jumpstarted Austin, but well give the credit to Mr. Dell. The answer is technology disruption is owned by the 11th District. I think out in California they think they own it. No, you guys own it. What have you learned about technology disruption in our two Americas?

KAPLAN: Well, the first thing I’ve learned is no one owns it. It’s everywhere. It’s affecting every mall. It’s affecting every business. It’s even affecting higher education. People used to think higher education, it’s not going to get disrupted. It’s getting disrupted. It’s everywhere. And it’s springing up in every state in this country. And so what does it mean? It means workers are far more likely in the next 30 years to have to find a new career or a new job during their career, which means skills training is much more important.

Worker adaptability is much more important. And the problem is, worker mobility is declining, it’s lower. So it means if you’re going to find a new job, it’s probably going to have to be locally, which is why we’re spending a lot of time in the Dallas Fed and in our research focusing on creating these partnerships between businesses, educational institutions, nonprofits, to create skills training for a whole series of jobs to let people who get—who lose their job to get trained and back into the workforce. We’re doing it much more in the United States, but not quickly enough.

KEENE: OK, we did that when the Cowboys won six Super Bowls in a row. We called it the community college model. Is that the model that works? Or what’s the new community college model?

KAPLAN: It has to be—community colleges are a part of this. It has to be a partnership, OK? So we have a number of businesses in our district. They have to get together—and we help facilitate this at the Fed—we convene people—they have to say: We need so many pipefitters, automotive technicians, registered nurses, insurance specialists, you go on and on, the IT people. And we have enough slots that—to the local community college—if we create a training program we can take these people.

KEENE: You’ve seen tangible results of that.

KAPLAN: You see it all over the state and all around the country. My concern is it’s not happening fast enough. We have to scale it up. And the reason it’s not so easy to scale, it’s got to be done locally. It’s not the kind of thing you scale nationally so easily, because it has to be done locally because worker mobility is lower. That’s why this is so hard.

KEENE: Link this idea, and frankly many other ideas, to the tragedy—I haven’t read about it in Texas—but we have an opioid epidemic across a beleaguered middle-west. And I’ll pick on West Virginia, Ohio. I’m sorry, Senator Portman, that I did that. But there are these geographies of incredible disassociation from the world of economics and the world of a better America, as President Obama called it. What do you need to do in the 11th District to jumpstart those people who are truly outside the good—(inaudible)?

KAPLAN: So all the work we do—first of all, there’s a trend, as you know, of people moving from rural areas into cities. But the big trend and the big thing that you keep coming back to is if you have lower levels of educational attainment you are more likely to have poor health, you’re more likely to use drugs, you’re more likely to be incarcerated. Everything that’s bad is more likely. You’re likely to have a shorter lifespan. And so I think the two things that can be done—I talked about workforce development. But there’s a second thing, which also I’ve spent a lot of time on, early childhood literacy. So we have to improve the school system. But what happens is all our work shows, that we look at, says if you start kindergarten behind, you never catch up. OK, it’s already too late.

KEENE: Yeah, Minneapolis has done great work—

KAPLAN: They do great work in the Minneapolis Fed on this. And so—and we’ve piggybacked on that. Zero to five, we’ve got to do much more in this country—

KEENE: Why can’t—away from the Dallas Fed, we’re dealing with a guy out of Kansas who owns leadership and own great service to Harvard Business School. Why can’t we jumpstart this? What’s the impediment? What is the constraint to getting the 5-year-olds jumpstarted?

KAPLAN: I’ll give you my own view. And this is somebody—I’m speaking for myself—spent a lot of time in the nonprofit world, Ford Foundation, on this. First, awareness. Just making clear people—has to be done locally, because in other words you’re going to—you have to do this with a local program. So you’ve got to make business leaders aware of it. Government is unlikely to allocate enough money to solve this. So it means business leaders and nonprofits have to get together or you have to form nonprofits so that kids are read to, if their parents don’t do it, at ages one, two, three, four and five. And so I think this takes leadership. And this is something that business leaders, majors in this country and spending time on. But it’s going to take—I think we’re waiting for the government to solve this problem.

KEENE: You say the government. You mean Washington. What—

KAPLAN: Any government, or state government. If you’re waiting for government to solve this, you can stop. They can do it, but it’s got to be done from leadership—leaders locally. And I’m talking business leaders, community leaders, nonprofit leaders, and, yes, local government leaders need to take ownership of that. I think they are. And this is one of those things we’re just not doing it nearly fast enough given the demographic trends, which suggest if you don’t improve educational attainment levels 20 years from now, wealth inequality is going to grow much—to a much greater degree.

KEENE: Within that wealth inequality, and you mentioned this earlier in our discussion, is the concept of age. And you talk about an aging America. I looked last night out on Twitter there’s a wonderful six-decade distribution of Japanese population dynamics. It’s amazing to me—

KAPLAN: Terrible problem there.

KEENE: —to see those issues. How do we deal with that as a public policy?

KAPLAN: And by the way, I’ll just—I’ll mention on Japan. They have a much worse demographic issue than we do. In that they had very slow GDP growth.

KEENE: Italy is the same.

KAPLAN: The one thing they have that we don’t, they have a very high savings rate. And they can—they’re highly leveraged, but because the central bank has bought a lot of the debt, they can restructure this. We are very highly leveraged also. So we really—we’ve got to grow faster. And the problem is as the workforce ages, we can create incentives for people to work longer, but there’s no getting around. Even if we do that, we’re just delaying the inevitable. Participation rates re declining.

Now, how do you solve that? Workforce development would help. The second thing that would help is immigration. I know it’s controversial, but sensible immigration reform. Immigration has been key to this country. Immigrants and their children have made up over half the workforce growth in this country over the last 20 years. And it’s our judgement at the Dallas Fed that if you go out the next 20 years, it’s going to be higher than that, because of aging demographics. So if we do things that limit sensible immigration, we are likely to slow GDP.

KEENE: Yeah. Based on what you’re saying, you’re not going to get the new slots at the White House. Within that is what is the tone out of Washington, and what many perceive to be an anger across this nation about immigrants, anger about this, anger about that. I’m sure you see that within the 11th District. How do policymakers move beyond the angers of 2017?

KAPLAN: So, actually, within the 11th District I think I wouldn’t—I would say it’s a little bit more balanced, the view, because of the fact we’re right on the border with Mexico. I would say the following: When I go around Texas, New Mexico, and Louisiana, which is primarily—and I talk, go to rural areas, and we talk about what the actual trends are, I think—and we’ve talked about this fact—globalization is increasingly being conflated with technology-enabled disruption. What I mean by that, 20 years ago many jobs that were lost in this country were due to globalization. And we can go industry by industry and give examples. Today, not so much.

Technology-enabled disruption is far more responsible for job displacement and the trends we’re seeing than probably globalization is. And the point where I think part—key elements of globalization are more likely to be part of the solution than part of the problem, because I think a lot of the disruption we’re seeing is due to technology. And I think we’re mixing them up. And I don’t think we’re being well-served by it.

KEENE: How does the Dallas Fed—I mean this seriously—how does the Dallas Fed respond to the idea that on this morning in Abilene there’s somebody with brown skin worried they’re going to be picked up by the U.S. government? That’s a new feeling for millions of Americans. What does your research is better outcome to that reality?

KAPLAN: Well, I guess I would observe the following—and I’ve said this publicly a few times—several times, and I’ll say it again. Consumer is 65, 70 percent of the economy, OK? And so I’m sensitive to anything that affects consumer spending, particularly among groups that have a very high propensity to spend, which tend to be lower, middle-income groups. So health care reform I’m very sensitive to, to the extent people are more concerned about access to health care, access to be able to get subsidies or be able to be eligible for Medicaid, they are more likely to save than to spend.

And there are millions of immigrants living in this country. And to your point, they are not going out and shopping. They are staying home. They’re afraid if they go out they may not come home. On margin, and it’s too soon for the data to pick it up but I’m hearing it anecdotally and I believe we’re going to see it, I think those people are more likely to save than to spend. And those two affects have some muting effect on consumer spending and, therefore, GDP growth.

KEENE: Within that, and with the responsibilities that Chair Yellen has—I don’t want you to speak for the chair—but I would suggest that she has a huge burden and responsibility as we somehow normalize ourselves back to rates. Do you believe we could do that for that person in Abilene or for the rich guy outside Dallas who’s employing 800 people? Can we do it in a way of stability? Do you worry within the media about the doom and gloom if we raise rates six times in 2017 there’ll be instability? How do you respond?

KAPLAN: Well, so my own view is the following. In light of—

KEENE: And notice how I got raise rates six times in there, just to—

KAPLAN: I got that. We’re not going to do that in a—in a rapid way.

KEENE: OK. (Laughs.)

KAPLAN: I believe because of these secular headwinds, and we say this—I say this over and over again—I think, while I believe we should be removing accommodation because I think we’re getting—we’re near full employment and, while it’s been frustratingly slow, we’re moving toward our inflation target, although I think not yet over the next few years. We should be removing accommodation. But it’s got to be done patiently and gradually. For those who say, why aren’t you raising rates more dramatically, I think these secular headwinds we just talked about, these factors that make this economy different than 10 years ago and 20 years ago means that we at the central bank need to be much more careful how we remove accommodation. And that’s why my own view is everybody—every people—everyone around the table has an independent view. I believe we should remove accommodation, but gradually and patiently, because I don’t think this economy is running away from us. I don’t think inflation is running away from us. I wish it were. And I think we need to do this in a very careful way.

KEENE: You have a wonderful heritage here for this question, the idea of Dallas, McTeer, Fisher, Kaplan. And yet, you lived for a long time in the People’s Republic of Cambridge. How far is Dallas away from Rosengren in Boston? What is that divide? Where’s the Venn diagram of a different view versus Dallas?

KAPLAN: It’s interesting. I knew Eric Rosengren when I was in Cambridge. And you know, I think the great thing about the Fed, I’ve learned, they’re great people but around the table each of them gives an—does an independent analysis of the economy and gives a view on what’s going on in their district. And so, you know, my views on this—well, I won’t—I won’t compare them to others, but they’re very similar to many people around the table. But they come—each come from different districts. There are some things we have in common, and a number of things that I said. These secular trends affect all of us.

The other thing I think I hear about everywhere is the skills gap. So I’ll just get this in, the skills gap in the United States meaning. With all these issues we just talked about in educational attainment, there are more openings for skilled workers than there is supply of workers. So part of this educational attainment issue, and this—the urgent need for workforce development, is we’re missing enormous opportunity—and this is probably true in every district in the country, where businesses cannot find skilled workers. I think I quoted the NFIB survey—small business survey. And less—I think almost 50 percent, I think 48 percent of them reported they can’t find workers to fill skilled jobs. So this is a big opportunity. So, while each district in the United States is different, there’s a number of these trends and themes we have in common.

KEENE: What are the adjacency effects of low taxes? Texas is on fire. It’s always been on fire. And a lot of that is tax policy. I looked at the personal savings rate to disposable income—savings rate to disposable income back in 1947, and the regime seems to be one with a lower aggregate tax set. And then the next 10, 20 years was with a higher tax set, which brought down savings. Is that the Texas distinction is different tax policy?

KAPLAN: I think there are a number of things: First of all, pro-business culture; relatively lower level of regulation; yes, central location. Yes, there’s the tax issue. Some people attribute some of it to the weather. But I can tell you this, having spent a lot of my life traveling to Texas with my dad, a jewelry salesperson. Texas is a very welcoming place for people who move there. Most people I meet, most CEOs I know in state, are not from Texas. They’ve moved there. They migrated their business there. Taxes might not have been the reason; might have been workforce availability. It might have been the fact that other businesses that are related to them have moved there.

KEENE: Right.

KAPLAN: So there’s an ecosystem that makes it a very attractive place for businesses to move.

KEENE: We’re going to get to questions. I’m going to ask one more question.

Benn, I’m going to go to you first, so you get a warning. I’m going to go to Benn Steil here with the first question.

But I’ve got one more question. Kathleen Hays and I go back and forth on this. The idea—I have this phrase, a border tax. Isn’t there no border? It’s a tax against everything. Where are you and where are your Ph.D.s on the efficacy of an import tax that I believe has more countries involved than Mexico?

KAPLAN: So I’ll answer this in an apolitical way, as you would expect.

KEENE: I would expect.

KAPLAN: Yeah. So our analysis is as follows. And I’ll go through the pros and the cons, which is the only way I know how to do it. The challenges will be there are going to be winners and losers from this. For example, retailers have made very clear, people in our district—


KAPLAN: —that it will eat into their margins. And I think a lot of people and businesses and people are focusing on the fact that, boy, businesses they didn’t think imported that much turned out to import a lot more than they thought. Imports are very critical to competitiveness.

And then the second issue is what’s the effect on consumer prices here? Now, the counter to that has been that the currency will adjust, but the truth is it’s a big uncertainty how much the currency will adjust. And will it adjust enough to offset the fact that this border tax has to be paid by consumers here.

And then the third thing, which you don’t know and you can’t quantify, is retaliation. What’s the likelihood of retaliation? It is critical to the United States, and certainly to U.S.-domiciled companies, to be able to sell goods overseas. A lot’s been made recently about the fact that of S&P 500, neighborhood of half revenues and profits—

KEENE: Right.

KAPLAN: —come from outside the United States. If there’s retaliation, what will be the effect on U.S. companies and U.S. employment? So I think there’s a lot of uncertainties. If you could get through those five years from now, certainly it will create incentives for people to locate manufacturing here—

KEENE: Right.

KAPLAN: —or locate facilities here. But I think there are an enormous number of uncertainties. And I don’t think there’s been enough time to analyze, in my judgment, particularly the retaliation issue. What’s the likelihood? And so I think that’s one of the reasons why this may—you know, people are very concerned about implementing this kind of policy.

KEENE: Let’s go to Benn Steil. You’ve been so much a part of the discourse in the nation about economics. Start there.

Q: Thanks, Tom. Benn Steil.

I’ve been at the Council now since 1999. I’ve been involved in developing this particular speaker series. If you go back to those early days, when we used to have Fed speakers, if anyone in the audience had the temerity to ask about the U.S. dollar, we were immediately told that’s not our area; please ask the Treasury. Fast-forward, particularly since the financial crisis, and there’s been much less reticence from Fed guests here about talking about the dollar, and acknowledging that what the Fed does has an impact on the dollar, and what the dollar does has an impact on what the Fed does.

KEENE: This is actually—I’m hard-wired not to ask you about the dollar. Benn, you’re 100 percent right. (Laughter.)

KAPLAN: And I agree with both those statements—(laughter)—meaning it’s—what we do has an impact on the dollar. And the dollar impact, as we saw, for example, in the first quarter of 2016, has a ripple effect, particularly in a much more globally connected world. So it’s a factor that I take into account and I watch very carefully.

KEENE: Within that, is Janet Yellen central banker to the world?

KAPLAN: We’re central banker to the United States, but we understand that actions we take have ripple effects throughout the world, and we have to be cognizant of those.

KEENE: Benn, jump in right here.

KAPLAN: I don’t think there’s an option anymore to be central bank to the United States without having a very good understanding of economic conditions around the world.

Q: You’re very relaxed about talking about the dollar. You’re—

KAPLAN: I don’t know if I’d call me relaxed, but—

KEENE: He’s from Dallas. (Laughter.)

Q: Since the crisis, in general, when we’ve had speakers from the Fed, they’ve been fairly relaxed. That wasn’t the case—


Q: —before the crisis. What has changed in terms of the culture or the way the international economy is operating that makes you feel that this should be part of the conversation?

KAPLAN: Well, listen, I’ve been a businessperson in the markets my entire adult life. And so it probably is fair to say that while globalization has been a key part of my entire and our entire careers, financial markets, asset allocation, ripple effects, and the fact that China is so much bigger today than it was even 10 years ago, so what goes on in China is going to have an effect on the United States, and vice versa, that may be part of the reason why you’re seeing that.

KEENE: So my follow-up question to that is: Is renminbi strength going to cause a delay in June? I’m not going to ask that question.


Q: Stephen Blank.

Living in New York now, collapsing infrastructure around us has become a daily issue.

KEENE: Excuse me. They paved 59th Street.

Q: (Laughs.) Debt is high.


Q: But interest rates are still quite low.


Q: Is this the moment to use—to leverage low interest rates to have a massive infrastructure rebuilding plan? Or is the debt issue more powerful than—

KEENE: Great question.

KAPLAN: I think that’s one area—I’m very sensitive to policies that would increase debt to GDP, but I do think infrastructure is one that would be worth—because it’s a long-term investment. And so, by our estimate, we’re probably in the neighborhood—studies I’ve seen $3 trillion underinvested in the United States in infrastructure, maybe higher; you say 4 (trillion dollars).

Anything that affects growth in the workforce or productivity—and I think infrastructure spending certainly affects productivity—I think—and that may include, by the way, digital infrastructure. We need to build out increasing speed of Internet in many cities. I think—now, the good news is, with rates so low, I think not all this, but a lot of it could be done with private capital, particularly if it’s a revenue-producing project. But I do think it would be wise, with rates this low, to be examining the advisability of spending on infrastructure. I think that could be a positive thing.

KEENE: It’s a great question. And let me bring it to Texas, which is the miracle that was DFW a million years ago, where I see the airport at Denver; maybe the Big Dig even in Boston.

How is not in my backyard done in Texas? There’s less—my perception is there’s less not in my backyard in Texas.

KAPLAN: There’s less of it, but it still exists. And—but there’s a great commitment, with the growth in the state of Texas, in Austin, Dallas, Houston, San Antonio, to build out infrastructure. And we understand and I think the leadership in Texas understands that if you’re going to have continued migration, you need to improve infrastructure.

KEENE: To make that 100 basis points of extra GDP, you’ve got to have it.

KAPLAN: Now, if you talk to the people working on the train project from Dallas to Houston, they would—

KEENE: There’s a—I don’t know this. There’s a train project—

KAPLAN: There’s a consideration of a train project; may not happen.

KEENE: This was from the Alamo, right? It’s been—

KAPLAN: Right. But—

KEENE: —a consideration.

KAPLAN: But seriously, these high-speed trains. I think one of the most attractive places in the country to do this is Dallas to Houston. And for that, they need easements all along the path, and I think it’s very challenging. So not in my backyard is still alive and well.


KAPLAN: And it’s an issue, sure.

KEENE: Interesting.

In the way back, please.

KAPLAN: Henry.

Q: Hi. Henry McVey.

You talked about technological change. You talked about China and demographics as reason to be cautious. But you didn’t talk about the size of the Fed’s balance sheet.


Q: So can you incorporate that into your thinking?

KAPLAN: Sure. So the Fed’s balance sheet is $4½ trillion. About 2½ trillion (dollars) is treasuries. Approximately 2 trillion (dollars) is mortgage-backed securities.

I’ve said publicly, and I’d reiterate it today, I still think the base case on the fed funds rate for this year is, including the March increase, I still think 3 is still a good base case. And in addition, I believe we should be announcing plans for the balance sheet sometime soon, and I think we should begin the process of letting the balance sheet run off. We’re not selling securities. We are just simply not replacing securities as they mature. I think we should begin that process later—sometime later this year.

KEENE: What is the timeline of that runoff? Do you have any studies of how many years that is?

KAPLAN: Yeah. Sure, of course. It’s going to take years to do. But we’re going to do it particularly—we’re going to do it with a number of mechanics, which I won’t—I’ll wait for our formal communication.

KEENE: Sure. Sure.

KAPLAN: But you’ll see us do this in a gradual, predictable way. It’ll still take years for it to run off, but you’ll see some phase-in that would—our goal is, and my own goal is, that we do this in a way that doesn’t unduly affect either the Treasury or the mortgage-backed securities markets.

KEENE: How are they linked? I mean, to Henry’s good question, how are balance-sheet dynamics and the runoff linked to the block and tackle of what are you going to do in June of this year, for that matter—(inaudible).

KAPLAN: I personally—I still believe fed funds rate should be the primary policy tool. And letting this balance-sheet runoff should be happening basically in the background.

Having said that, I’m sensitive that in the early stages of this there’ll be a lot of market sensitivity, and we’re going to have to take that into account and manage the choreography of how we manage fed funds rate as well as the balance sheet.

KEENE: Manage the choreography. That’s the most important statement—

KAPLAN: With the tactics.

KEENE: —you’ve made here.

KAPLAN: Yeah, the tactics of it.

KEENE: The tactics.


KEENE: How do you do that? I mean, Chair Yellen says it—I mean, this is fascinating. This is original territory we’re on here. Do you do it at a press conference? Do you do it at a speech at the Economic Club of New York? I mean, I love your phrase, managed choreography.

KAPLAN: I won’t—I think I’ll—I would be wise not to comment on exactly how we’ll do it. But I think you’ll see us in—sometime soon, which I’m quoting the Fed minutes from the last meeting—sometime soon you’ll see us announce an—

KEENE: Managed—

KAPLAN: —update to our plans. And in addition, you’ll see us begin—I think the process will likely start actually sometime later this year.

KEENE: How have the geniuses at the Fed studied the managing of the choreography?

KAPLAN: Well, you’d use your judgment. And the other thing you look at is average daily volume in the Treasury market, in the mortgage-backed-security markets. You look at the future path of maturities to try to get a sense of that. And again, the goal is to try to do this in a way that minimizes the impact on the Treasury markets as well as the mortgage-backed-securities markets.

KEENE: This delicate discussion brings up—and I don’t want to, of course, name names—but should we have someone who understands these dynamics and glide paths as a next chair, next vice chair, et cetera? Or can we have someone more Kaplan-like? (Laughter.) Do you need a Ph.D. in differential equations—

KAPLAN: So it—

KEENE: —to run this—

KAPLAN: It won’t shock you that I will—I’ll stay away from the specifics of the question.

KEENE: I have to ask.

KAPLAN: We have an excellent—first of all, all of us around the table spend a substantial amount of time learning about this. But also we’ve got a very sizable markets group and markets professionals at the Fed who are outstanding.

KEENE: Who are trying to figure out what managing the choreography means.

KAPLAN: Well, no, they’re very active daily in the markets, and they do an excellent job briefing people like me, educating me.


KAPLAN: And they do it for everyone around the table. So I think—I won’t get into who sits where, but I think we’ve got—

KEENE: We’re just among friends here.

KAPLAN: I understand.

KEENE: You know.

KAPLAN: I appreciate that. But we’ve got an excellent staff. You need superb markets people at the Fed, and we do have that.

KEENE: I love that concept of managing choreography.


Q: We may or may not be at a moment that significant tax reform could be undertaken in this country. What would be your wish list of things to include in a tax reform that would promote the goal of reducing the rising inequality in this country?

KAPLAN: So let me step back 100,000 feet. There are two things that grow GDP—growth in the workforce, increases in productivity. OK, so I’m sensitive to any fiscal or structural policies that affect those in a sustainable way, OK. So I’ve said this publicly. To the extent we did tax reform, corporate tax reform, where maybe we increase incentives for capital spending and we make it more likely for businesses to want to domicile and locate here, I think that could be positive.

What I’m more sensitive to, and I’d be a little bit more cautious about, is tax cuts, either individual or otherwise, that are funded by increasing the debt, because my concern is, while those might create a short-term bump in GDP growth, as we get over the horizon, growth will then go back to where—basically where it is today, except we will have higher debt to GDP. And I’m already concerned that the debt to GDP we have is not sustainable.

So I’m much more interested in tax incentives that encourage people to spend here, capital spending, employment. And I’d underline the word reform rather than cuts that are financed by increasing the deficit.

KEENE: And yet that’s the dialogue right now in Washington, within the gridlock that we have in Washington, and, of course, with all the other outside events going on.


KEENE: This morning people are simply talking about the efficacy of outright cuts versus any reform.

KAPLAN: So I’m focused—in my job, I’m focused on sustainable GDP growth, not something that creates a short-term bump in GDP but increases debt to GDP. I’m interested in either fiscal policies or structural reforms that increase sustainable GDP. And that, I think, would be—if you ask my own opinion—

KEENE: Right.

KAPLAN: —as a central banker, those are the types of policies I’d be—I think be more appropriate.

KEENE: And within the grind that you do, which is this—you know, I’m sure there’s days where you wake up and you’re at lunch and you don’t know which town you’re in—I’m serious—within the—

KAPLAN: Especially if I’m waking up at lunch.

KEENE: Well, you know—

KAPLAN: (Laughs.)

KEENE: But you’re at lunch and you’re waking up in some town or whatever; you know, like, where am I?

KAPLAN: (Laughs.)

KEENE: And what’s the town, and what am I doing? Those people in that audience, what do they want in health-care reform? Do they want Obamacare? Do they want Trumpcare? What’s the message you’re getting to this good question on tax reform?

KAPLAN: So I’ll—

KEENE: What’s the message on health care reform?

KAPLAN: In this job, unlike other jobs where you’ve talked to me in the past, I’m very careful about getting too deep in fiscal and other policies.

KEENE: You don’t have to. What do they want?

KAPLAN: Well, so let me say the following. And I’ll put it this way. Again, the consumer is 65 or 70 percent of the economy. I—and we know that at lower income levels, lower and middle income levels, those people have a very high propensity to spend. And they are spending. And we know that the improvement in the household balance sheet since the great recession has been a key underpinning of this economy. Debt hasn’t actually declined, but debt to GDP, debt to income, has declined. And I think the consumer has a capacity to spend.

So what I’m sensitive to is if there are policies that make it harder for those types of consumers to have confidence that they’re going to have access to health care, particularly as they get older in an aging society, to where they were more likely to save than to spend, I think that actually could be—create a headwind or create a dampening of GDP growth.

KEENE: Right here.

Q: Andrew Gundlach.

What’s the message that you’re getting about the energy markets? And two specific things: Are the CEOs you’re talking to preparing for permanent reduction or sustainable reduction in regulation?


Q: Or is it cyclical? And the second thing, more long term, if you think about the U.S. on the global cost curve of energy, the debate is that we’re the lowest cost because we don’t have the social costs of Russia and Saudi Arabia, or we’re the highest cost because the true economics are just not the same as the geology in the other places. How do you see it?

KAPLAN: So let me comment on what’s going on in the energy business. And I’ll come back to the regulatory part of this. But let me just start with the headline.

The United States, at its low—actually, last year was about 8.6 million barrels a day. That’s as part of a global market that’s about 96 million barrels a day oil, oil equivalence. It is our view at the Dallas Fed—and we spend an enormous amount of time on this, and I spend a lot of time on this—we’re moving toward finally, after two or three years, global supply-demand balance. One of the reasons, though, we’re moving—it may be a little artificial in that it’s OPEC and other oil-producing nations have agreed to 1.8 million barrel-a-day cuts.

Here’s the issue. And that’s why I would call this a fragile equilibrium, at least in the short run. And I’ll get to the long run in a moment. We spent the last two years where U.S. production was declining. It was very painful. Those declines were more than offset by increases in OPEC and other oil-producing nations.

Now we have a situation where OPEC and those nations have agreed to cuts. Now U.S. production is increasing—8.6 (million barrels) at the low, about 9.2 (million barrels), 9.3 (million barrels) right now. And our own research and our contacts suggest we’re going to end this year at 9.7 million barrels a day. We do an energy survey every quarter, which find, at this level we’re at now, 45 (dollar), $55 band, it is very profitable to drill in a number of locations, particularly in the Permian Basin, which is why you’re seeing drilling increase.

The issue is and the fragility is will OPEC continue to extend these cuts as they see U.S. production increase? This is one of the reasons why I think OPEC very deliberately has not extended cuts beyond six months. It creates some dampening effect on prices, because while I think they’ll continue to extend the cuts, they don’t want to see—it’s painful for them to watch U.S. production go like this.

Now, all this is based on 1.3 million barrels a day average demand if you go out longer. So it’s fragile in the next couple of years. If you go out five or six years, if—and this is a big if—if demand stays at 1.3 million barrels a day, we’re more likely, in our judgment, to get to an undersupply situation five or six years from now than oversupply.

Shale, in the meantime, will be a modulator. I think you’re going to see increasing shale production. The majors are now increasingly investing in shale. So I think that’ll be a modulator on the price. So our best judgment is we’ll probably stay 45(-dollar), $55 range.

To your regulatory-question point—and this is true of businesses generally—I think the regulatory relief—not that there’s going to be a rollback in regulation but the fact they have more predictability—there isn’t going to be increases in regulation—I think most business people, particularly in energy, have found that very useful.

KEENE: What has your wonderful Energy Department learned about the elasticity or the responsiveness of modern oil and modern oil technology? We are all living within the—not nostalgia, but the ghost almost of 1986 and dynamics of, say, a VW diesel is one consumer item. But what do we know now about the responsiveness of price?

KAPLAN: So we know that breakeven levels, heavily due to technology, have gone down, OK. What offsets that is there’s a shortage now of crews and high-quality crews, which is starting to be a limiting factor on increasing drilling and will start to increase costs. But technology is continuing to improve. And what’s the impact of that?

If the Permian Basin today produces about 2.3 million barrels a day, there are many people that I talk to who think we will ultimately, because of technology, be at multiples of that in the future, because technology is getting so much better. So you’re going to see U.S. production, subject to price, because of technology, continue to increase.

Now, the one thing I’d say, shale is often referred to as a—as a swing producer. It’s not actually a swing producer. I’d prefer to call it and people in the industry prefer to refer to it, short cycle, meaning you can’t just push a button and shale gets back online. There are some delays. And because there are shortages of workers, particularly crews, that’s going to make—that’s going to create some lag time as people want to increase—they’re right now increasingly struggling. This is part of the skills gap. Oil-field and oil-field services crews are in short supply.

KEENE: One more question. Sir.

Q: Hi. Juan Ocampo. Thanks for coming.

I want to follow up on your comment about the importance of local efforts by CEOs and the others.


Q: And this may have less to do with the 11th district, but your colleagues in St. Louis, Philadelphia, Cleveland. There’s been a lot of consolidation across many issues. Banking is one that you’re very familiar with. The 11th district had a lot of headquarters, banks, that are now gone.

KAPLAN: Right.

Q: But it doesn’t stop there, particularly if you think about St. Louis, that district. Has that created a lasting problem that you just don’t have the fabric of the business leaders to do this? And what can you do about that?

KAPLAN: So it’s an interesting question. I’ve seen it even in my previous life, going into many communities in this country. Yeah, the business leadership in most cities of 10 and 20 years ago has changed, because a lot of it, to your point, is because of mergers. And there are now—the mix of business leaders is now different. So you have the long-time businesses, but you have a lot more entrepreneurs and other business leaders in the room; financial services, independents there. And so the old coalitions that used to happen to launch many of these local initiatives are different.

And so one of the reasons why we’re working on this at the Dallas Fed, but I think a lot of other Fed banks are doing this, is there’s a need for institution locally. It doesn’t need to be us, but somebody needs to be a convener and get people together, not just businesses, but with nonprofits and educational institutions, to talk about these issues and then facilitate them forming partnership to deal with them. And I think—I think there’s a real need for that. And the changing business community, because of mergers and consolidations, makes that a little bit more challenging.

KEENE: Robert Kaplan, we’re out of time. Thank you so much.

KAPLAN: Thank you, Tom. (Applause.)


This is an uncorrected transcript.

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