Narayana Kocherlakota is one Federal Reserve policymaker who's had a very interesting intellectual journey over the last three years. Not that long ago, the president of the Minneapolis Fed was hand-wringing about whether there had been a major jump in "structural" unemployment -- a weak job market compounded by economic problems that cannot be easily fixed by easy money policies. He pondered whether the Fed's near-zero interest rates were having the counterproductive effect of encouraging deflation.

Narayana Kocherlakota, president of the Minneapolis Fed (Source: Federal Reserve Bank of Minneapolis) Narayana Kocherlakota (Source: Federal Reserve Bank of Minneapolis)

But over the last three years he has moved gradually but unmistakably in the opposite direction. He concluded that, no, structural problems weren't a major driver of high unemployment rates, and, yes, monetary policy could help get the job market on track.

His journey to the dovish end of the Fed spectrum culminated Thursday with a speech that puts him among the intellectual leaders of the faction within the central bank that wants to move most aggressively to boost the U.S. economy. It is "A Time of Testing," Kocherlakota said, invoking a line from Paul Volcker.

The problem Volcker faced as Fed chief in 1979 was an uncomfortably high inflation rate coupled with insufficient resolve to fight it from the central bankers. The Fed's lack of credibility and half-hearted efforts to stop inflation were self-fulfilling.

The U.S. economy has the opposite problem now: too-high unemployment and too-low inflation. But Kocherlakota is arguing that, again, resolve by the central bank is the solution. Here is his key argument:

I’ve spent a lot of time talking about 1979, because I see three key parallels between the economic situation in 1979 and the economic situation in 2013. First, just like in 1979, the Federal Open Market Committee faces a challenging macroeconomic problem—although this time, the problem is stubbornly low employment as opposed to stubbornly high inflation. Second, there is a widespread perception that monetary policymakers lack either the tools or the will to solve this problem.


And third, the perception of monetary policy ineffectiveness is itself a key factor in generating the problem. Let me elaborate on this last point. If the public thinks that monetary policy is ineffective, then it will expect relatively weak macroeconomic conditions in the future. But these expectations about the future have a direct impact on current macroeconomic outcomes. If households expect their incomes to be low in the future, they will save more and spend less today. If businesses expect low future demand for their products, they will invest less today and hire fewer people today. In this way, any perceptions of future FOMC ineffectiveness in generating favorable macroeconomic outcomes are hurting current employment.

In other words, to the Fed needs to do "whatever it takes" to get growth back on track, sticking to low interest rates, growth above longer-term trends, speedy job creation and inflation somewhat above the 2 percent target. If the Fed creates the appearance that it will pull its support for the economy anytime things start to improve or inflation edges up a bit, the policies won't work.

Just as Paul Volcker's Fed kept interest rates ultra-high even as inflation was plummeting in the early 1980s, the current Fed must keep easy money in place until the long-depressed economy is truly out of it rut, Kocherlakota says.

Kocherlakota is not the first to frame the current situation as the inverse of Volcker's challenge in 1979; see this Christine Romer op/ed from 2011, for example. But Kocherlakota's comments are the most explicit embrace of this line of thinking from a current Fed official. A counterargument would be that easy money policies are creating risks in financial markets that have costs of their own (see Fed governor Jeremy Stein's argument, for example).

But it is nonetheless fascinating to see such a clear statement of vision from Kocherlakota, who has let the facts over the last three years change his mind -- something that all too few policymakers would do.