MNI INTERVIEW: Kaplan Says Loose Fiscal Is Holding Up Fed Cut
Ex-Dallas Fed President Robert Kaplan says whole-of-government approach is needed on inflation.
Former Dallas Fed President Robert Kaplan told MNI the central bank needs to refrain from cutting interest rates perhaps all the way through this year depending on incoming data, blaming the lack of relief on loose fiscal policy he says is propping up services inflation.
"I would be kicking the can down the road and I would not be ready to cut rates until I saw more sustained improvement but I would also be keeping my options open," he said in an interview. "I would be prepared to consider that we might do a couple and I'd be prepared to do zero," he said about potential rate cuts. He saw little cause for any further increases in borrowing costs.
The short-term neutral rate has probably climbed due to the strong and persistent boost to the economy from fiscal spending, Kaplan said. "Monetary policy is highly restrictive, however, fiscal policy is historically stimulative," he said. (See: MNI INTERVIEW: Fed Only Likely To Cut Once This Year - Giannoni)
"You've got very stimulative fiscal - there's the unspent ARPA money or Inflation Reduction Act projects, CHIPS Act projects, and there's infrastructure act projects - those spigots are open, stimulating demand while the Fed is trying to cool demand," he said.
SPIGOT IS WIDE OPEN
Kaplan fears America is paying a high price in order to potentially achieve a soft landing. He pointed to high debt-to-GDP levels and interest payments poised to overtake defense spending.
"We're buying this soft landing," he said. "These are the kinds of projects you would normally do after you had a recession, and we're doing it pre-recession, and the cost of it is higher interest rates."
The International Monetary Fund last week warned massive U.S. deficits have stoked inflation and pose “significant risks” for the global economy, expecting a fiscal deficit of 7.1% in 2025. The Congressional Budget Office thinks net interest payments will continue to exceed 3% of GDP and top USD1 trillion after 2026.
Kaplan blamed sticky services prices on fiscal spending, saying "my guess is it's going to remain sticky, as long as you've got the fiscal spigot pretty wide open."
MISSING THE POINT
"I would rather the whole of government approach, which includes taking a look at all elements of economic policy to fight this inflation," he said. "It would be unfortunate if the answer is everything stays the same and so the Fed is left to either delay much longer or take action" and raise rates.
The Fed also needs to do a better job explaining how fiscal spending is impacting the economy, Kaplan suggested.
"We have to recognize some of this growth and therefore the neutral rate is artificially stimulated, in my opinion due to fiscal policy," he said. "Saying the short-term neutral rate is high and therefore we're not that restrictive kind of misses the point. What's the reason that it's higher?"
"It's because of fiscal policy. So, one answer is to counter the fiscal policy with higher rates for longer and another option is to recognize that its fiscal policy and maybe slow down the fiscal policy."