A vocal Fed dissenter prepares to bow out

KANSAS CITY—Thomas Hoenig has, over the past two years, emerged as the Federal Reserve official most willing to challenge the ultra-easy money policies that the central bank has pursued. While most of his colleagues view near-zero interest rates and massive infusions of cash into the economy as the best hope to help the nation to emerge from its deep economic malaise, the soft-spoken president of the Federal Reserve Bank of Kansas City sees the central bank sowing the seeds of the next crisis. That’s why he dissented at all eight meetings of the Fed’s policy committee last year, and he would almost certainly be doing the same now if he had a vote this year. (Regional presidents rotate onto voting status every third year.)

 Hoenig is the longest-serving official at the table when the Fed’s policy committee meets, having become president of the reserve bank in 1991. He plans to retire this year. He discussed the risks he sees from the Fed’s easy money policies in his office with The Washington Post last week; below is an edited transcript.

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Washington Post: What’s behind the steep run-up in prices for oil and other commodities this year, and the decline in the last couple of weeks? Do you see broader inflation taking root?

 TH: When you put this much money into the economy, it’s got to deploy. Some of it is deployed into commodity assets. You’re going to have volatility in that environment, and we are seeing volatility. I can’t say that I’m surprised.

 If you’re talking about a long-term trend line, energy and commodities are trending up, partly because of demand factors, partly because of supply interruptions. I think you’ll see mostly a steady rise up in some of these assets, especially as monetary policy confirms the moves up.

 Remember, we’re in our third year of zero rates. That’s a long time to pump a lot of money into the economy.

WP: So is that happening now? Are peoples’ inflation expectations rising in ways that are dangerous?

TH: Think about it this way: The inflation of the 1980s started in the mid-’60s. It is a slow process along the way, but if you leave policy easy, then inflation will eventually catch hold.

 This inflation we’re seeing is in everything now. It’s not just in gas. I go to the grocery store — it’s not just food, it’s all the other goods there. Apparel. Companies are telling me, “We’re seeing 20 percent price increases in our inputs and passing along 10 percent or more.” We’re starting to see the psychology of inflation slowly change.

WP: One place where there’s not any inflation is in wages. Can you really have an inflation problem without wages rising?

 TH: Not initially. But people are losing real purchasing power, and that changes how they’re going to negotiate. People want this lost purchasing power back in time. In negotiating, they’ll say, “Prices have been rising, we deserve more.” We’re already seeing it in some of the surveys that we run. Businesses are telling us, “Yes, we had a pay freeze a year and a half ago, but we’re doing some catch up now. We want to make sure we keep our good people.”

WP: You’ve argued that there’s something fundamentally different about zero interest rates as opposed to rates that are low but not zero. Why?

 TH: Name a service, name a commodity that trades well at zero. Nothing trades efficiently at zero. Why would credit?

 Let’s say you’re a farmer. You have a good crop season. You’ve got this cash. Are you going to put it in a CD for 0.4 percent? No, you’re going to go out and buy that land next to you, borrow cheap, and bid up the price. What do I care when the alternative is so low? You get distortions in the economy. That’s what worries me. I was driving to work this morning and there was a big discussion about Hertz and Thrifty and Avis, a big war. [Car rental companies Hertz and Avis are engaged in a bidding war for competitor Dollar Thrifty]. The price went from a bid of $50 [per share] to some impossible number like $70. If you are in business, and you say I can grow this business internally by expanding, or I can buy something because I can borrow an infinite amount of money at almost zero, what am I going to do? You’re going to consolidate, not invest and grow.

WP: When do you think the Fed will begin to exit this period of super-low rates?

TH: I don’t know. The first thing you have to do, obviously, is you do have to explain it. You can’t just do it, you have to explain yourself, prepare not just Wall Street but Main Street. That’s going to take a little bit of time. That’s why I wanted to do it early on, and in very small steps to begin with, so people see it and understand it.

 By being understandably concerned about unemployment, and I am very concerned about it, you can actually add to the problem, because you create these bubbles when you get rates too low.

WP: How does this interact with the fiscal policy?

TH: I think it is one of the most difficult parts. About the time the economy really does start picking up speed, real interest rates will have to rise because of the high deficit, and that has contractionary effects, that puts real pressure on the monetary authority to keep rates low, and you get perverse outcomes.

 I like Bowles-Simpson [the approach to long-term deficit reduction reached by the president’s deficit commission]. It was a multi-year plan that showed people the path so they could have greater certainty about how it might proceed. I realize people have different opinions, but if Congress could promise the American people that was a starting point for deficit reduction, that would be very healthy for the economy.

WP: You are retiring on Oct. 1 after 20 years in this job.

TH: To the day.

 

WP: In what ways has the Fed become a stronger institution in that time, and what do your colleagues and successors need to change?

TH: The Federal Reserve has outstanding people working for it, at all these banks and at the board of governors. I say that without reservation. We do have a lot of knowledge that we can rely on.

 I do worry that we don’t have as much dissent as we once had. I think everyone feels you can have your conversations but you want to present a united front publicly.  We need to see more open discussion. I don’t think that’s harmful.

 I worry that there’s a desire to have more consolidation and conformity. I think reserve banks need to assert themselves more on policy and in operations issues. They have more of the grass roots and more of the operational knowledge than the board of governors does. The board should listen carefully to the reserve banks.

 
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