MNI INTERVIEW: Fed Right To Remain Cautious On Rate Cuts-Kohn

Federal Reserve officials should stay vigilant about inflation and remain cautious about cutting interest rates too quickly in response to signs of labor market weakness, former Fed Vice Chair Donald Kohn told MNI. 

“They are right to be cautious. It’s not clear that ex-tariffs inflation was on its way back to 2%,” Kohn said in an interview. “Maintaining at least a little tightness in policy is absolutely appropriate to guard against these inflation risks.”

Kohn flagged sticky services prices as an indication that not all the persistence of inflation is related to concerns around U.S. tariff policy. “If you lean too hard on the labor market weakness, you increase the inflation risk." (See MNI POLICY: Fed Takes Measured Approach To Post-Sept Cuts)

The Fed is at an especially perilous juncture as risks to both the employment and inflation sides of its mandate have climbed, said Kohn. He said the central bank’s quarter-point rate cut last week was justified in the context of a monetary policy stance that is “a little on the tight side.”

“There were a number of signs, including the rising unemployment rate, a gradual, slow rise, declining labor force participation, to suggest at least a modest weakening in the labor market which would itself help to contain inflation,” he said.

Still, Kohn believes “a cautious, gradual approach to this is appropriate. The economy is growing, there’s no real sign of recession.”

He said the Fed’s general assumption that tariff shocks are one-time hits to the price level is sound, but added “there's a risk, they need to be a little bit careful about that."

TOO SANGUINE

Kohn, who spent four decades at the U.S. central bank, said financial markets are priced for a really benign environment, perhaps overly so. 

“They’re priced to limited weakness in the labor market, that whatever is there is countered by declining rates keeping profits growing, keeping these credit spreads extremely narrow. They’re priced to good economic growth and low inflation,” he said. 

“But I think there are risks here. There are risks of leaning too hard against the labor market, there are risks that Fed Independence is compromised.  And maybe that's okay for the next year, that what the president wants and what's appropriate might be the same – I think the president wants a lot more than what's appropriate – but over the long run, that's a bad idea. Everybody acknowledges that.”

Kohn said that a Supreme Court loss for Fed Governor Lisa Cook, who is disputing her attempted firing by President Donald Trump, would represent a huge setback for central bank independence. (See MNI INTERVIEW: Cook Could Face Long Odds Before Supreme Court)

“It would be more than a threat. It would really undermine it quite substantially,” Kohn said. “It would say that a minor infraction before you entered service would be enough to get you fired.”

YIELD CURVE CONTROL

Kohn said the idea that the Fed could undertake yield curve control in order to anchor long-term yields, which has been floated in markets, would create more problems than it’s worth. 

“You can make one problem go away but create other ones,” he said. “This yield curve control kind of thing was debated even when I was inside [the Fed] around 2009 and 2010. And the problem, as was seen in 1951, was how do you stop and how do you end it? You lose total control of your balance sheet.”