How the Fed fights back, with Don Kohn

Being a central banker is hard work. Being a central banker under Donald Trump, that's even harder. After trying to fire Federal Reserve Governor Lisa Cook for alleged mortgage fraud and be rating Fed Chair Jay Powell for his stance on interest rates, the U.S. President this week escalated his attacks on the world's most important central bank. Trump's Department of Justice launched a criminal investigation into Powell over testimony he gave last year relating to renovations of Fed buildings in Washington, D.C. But, said Powell, "This new threat is not about my testimony last June or about the renovation of the Federal Reserve buildings. Those are pretexts. The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the President." Powell's term as Chair ends in May and Trump is set to nominate his replacement later this month, but with a new Fed Chair serve the public or the President. This is the economic show, I'm Claire Jones, the FT's U.S. economic editor, and I'm joined today by Don Cohn, a true Federal Reserve insider. Cohn spent eight years on the Fed's Board of Governors, including four as the bank's vice chair. He now serves as a senior fellow at the Brookings Institution. Don, welcome to the show. Thank you, Claire, for having me on. I'm looking forward to the conversation. Now, as we know, things move very quickly in Trump land. So, for the record, we are recording this at 4 p.m. on Tuesday the 13th of January, UK time, which is 11 a.m. for Don on the East Coast. Don, you spent 40 years in the Federal Reserve system. On a scale from 1 to 10, where 1 is Hunky Dory, and 10 is absolutely distraught. How do you feel about Trump's attack on J-Powell and what it means for the Fed? So, I'd say 10 or 11. I think this is really serious. Certainly, the most serious attack on Fed independence in my experience, it shows the Trump administration will stop at nothing to gain much firmer control over the Federal Reserve. So, I'm very worried. So, basically, this is a moment in time of historical significance in terms of the awfulness of it. What I think is also pretty unique is what we saw from Powell on Sunday, where he responded to the DOJ in quite aggressive terms and said, this investigation is a pretext. It's got nothing to do with the renovation of our headquarters. It's got everything to do with the White House's control of the Fed's independence to set interest rates as it sees fit. We've seen central bank governors back him up. We've also seen some Senate Republicans back him up too. Do you think that is going to be enough to convince Trump to stop? It's hard to know what's going to be enough to convince Trump to stop. But I think it should be a warning shot. And I think what Jay Powell did on Sunday was very constructive. Jay Powell, as you know, Claire, from attending those press conferences, has simply refused to talk about Donald Trump. He's tuned the whole thing out. He's trying to protect the independence of the Federal Reserve with respect to monetary policy. But this latest attempt by the Trump administration to intimidate him just pushed him too far. And I think it was very helpful that he called it out. He called it for what it is. And the fact that these to few senators and representatives have spoken out against what's going on and have fired warning shots at the Trump administration that they're not going to get a new chair through if they continue this behavior. I think is very constructive and would not have happened if Jay Powell hadn't have made that recording and spoken out. This is a very serious attack on the Fed's independence. But could it, do you think, have the opposite impact from what Trump thinks it will, where it galvanizes support for the institution? Well, I hope so. And I think that's what we're beginning to see. So I think Congress put a number of protections for protection of the Federal Reserve from short-run political pressure. Congress embodied that in several ways in the Federal Reserve Act when it created the Fed and when it's reformed it from time to time. It gave Reserve Bank presidents to say an open market committee decisions, presidents that aren't part of the political process. It gave the Fed budgetary independence and importantly it created fixed terms for the chair, a four-year fixed term for the chair, and 14-year fixed terms for the governors. And that's an important part of independence and the way to interpret what Donald Trump is doing, both respect the Jay Powell and with respect to Lisa Cook to try and intimidate people, to try to force them to resign because they're concerned about the attacks that they're undergoing and the expense of defending themselves against those attacks. So far, both Lisa Cook and Jay Powell have vowed to stay in place and I think that's very, very good. What do you think the atmosphere is going to be like within the institution now? Are people going to be rethinking is this the sort of atmosphere I want to work in? Or are people going to be really digging their heels and like Powell seems to be in saying, you know, enough is enough. We really need to do whatever we can to preserve the integrity of the Fed here. Let me be very clear. I haven't talked to anybody inside the Federal Reserve. I think what Jay Powell did on Sunday, after doing Sunday evening, will actually raise the morale of the people inside the Federal Reserve. They'll dig in their heels in your terms. They'll be proud to work for an institution that is fighting for its independence against a very powerful foe, the president of the United States. So I think the morale will be good. Now, hanging over everybody is the new -- who's going to be the new chair? And what will that chair do? And how will the board interact with the new chair? But right now, I'll bet there's a lot of encouragement and rallying behind the chair. Yeah, absolutely. And you mentioned the new chair note. This was the reason we had you on the show originally. We booked you before. We got the announcement late on Sunday night. When was the last time the Fed announced something on Sunday night? Did it happen during your time on the board? Well, certainly did. It certainly happened through the crisis. But the announcements Sunday night were -- here's how we're saving bear sterns. Here's how we're saving AIG. Here's what's happening to Lehman Brothers. So at one point, Ben Bernanke joked that his memoir was going to be entitled before Japan opens. Because we were always told we had to have our rescue plan and place before the Japanese markets opened. So, yeah, there have been lots of Sunday night announcements. But nothing, nothing like this. I mean, that's a remarkable story. But I think, you know, it speaks to the idea that like Sunday night announcements are usually associated with financial crises or, you know, something that's not usually as perhaps a self-inflicted as this by the -- by the sitting administration. But the reason, as I say, we were going to have you on this show is because, you know, we're expecting an announcement on who the new Fed Chair will be. Before we get to the ins and outs of the runners and riders, I think it'd be good to just get a sense from you of how powerful is the Fed Chair? Well, the Fed Chair is powerful, can be powerful, in his leadership role. So, certainly, the staff reports up to the Fed Chair. So, the Fed Chair has a lot of control over the staff. Is always the head of the F-1C, helps set the agenda for the F-1C. But the leadership of the Fed Chair comes through his demonstration of that leadership, his convincing other people that the decisions he wants to make or the policy changes he wants to make or the right policy changes. So, Alan Greenspan, Paul Falker, before him, Ben Bernayke, the three chairs I served most closely under, were very much in that mode. So, it wasn't dictating what was going to happen. It was recognizing there was a committee, the Board of Governors, for some decisions, the Open Market Committee for other decisions. And he had to convince those committee members that the policies he was backing were the ones that would accomplish the goals that the Federal Reserve was given by legislation. You refer to the Open Market Committee, which is the body that sets interest rates in the US. The Chair tends to direct the flow of the discussion and so on and so forth, but is in fact one vote among 12 voting members on the F-1C. Do you think that the external environment, where we've got, from saying, whoever he makes, Fed Chair, will have to support his view that interest rates need to be slashed, is going to lead to an environment where the rest of the F-O-M-C is rather suspicious of the new Chair, whoever that new Chair might be. I mean, how would you be feeling right now if you were sitting on the F-O-M-C, given what we've heard from the President about just how important low interest rates will be in deciding who he picks? So I think there's always a tendency to give a new Chair the benefit of the doubt. But I think the doubts will be much stronger given the environment and given the implication by the President or the statement by the President that he's not going to point anybody who won't do basically what he wants to do, which is the slush interest rates. So a new Chair will come in and could argue for lower rates, but as a member of the Committee, I'd be listening very closely to how those are justified. So the new Chair needs to use conventional economic reasoning, or reasoning within the conventional bounds, recognizing the dual mandate, demonstrating how lower rates will be helpful in beating the dual mandate. So there's a chain of reasoning. So the new Chair will need to convince people that there's a good story to tell, a believable story to tell about why that's the right call. One of the reason Trump says he would like low interest rates is not just to use the US economy, but also to cut the government's financing costs, given the deficit we've seen in recent years and now rather substantial. How do you think those sorts of arguments would play were the new Fed Chair to use them with the rest of the FOMC? I think they play very poorly, and they should play very poorly. The Federal Reserve has been given this dual mandate, or triple mandate, if you include the interest rates, maximum employment, stable prices. It hasn't been given a mandate to lower interest rates to help finance the federal deficit. That kind of thing is a path to higher inflation. So this is not the Fed's job. If the Fed fades its rates lower, in order to help the fiscal authorities, that's going to be highly inflationary. If rates are too low to produce stable prices, then they're going to produce inflation. So that argument will be very, very poorly received by the rest of the FOMC. So let's come to some of the runners and riders now. Who do you think are the main candidates in your mind who are likely to become Trump's pick? So obviously Kevin Hasse, Kevin Worsh and Chris Waller. So I think this is a really important moment. I don't think we've had, you can tell me if I'm wrong, a reaction from Chris Waller, have we to this? No, we have not. We've not heard publicly from Chris Waller yet. We've heard from Kevin Hasse, who is the White House's head of the National Economic Council, who said he supports the Department of Justice probe into power. I don't think we've heard from Kevin Worsh, who's a former Fed Governor yet. Waller is still a Fed Governor at the moment, and I think is very highly regarded within the institution. So what would your expectation be from now in Waller of how he's likely to respond to this? I do think Chris Waller is an institutionalist. He came from the St. Louis Fed, so he's very aware of the value of the Fed, Fed independence and the Federal Reserve system. I would expect him not to support the DOJ initiative here. Now I've heard him criticize the renovation, but I'd be very surprised if he had the same reaction that Kevin Hasse has. Now, Kevin Hasse is in a difficult position, because he is the NEC chair. There was a lot of suspicion about Kevin Hasse, that he would be the most client of the pigs, and he has just reinforced that. I think he raises a lot of questions about independence, more so than Kevin Worsh or Chris Waller would. There's another figure who's been involved in the process quite actively as well, Scott Besent, who's said an awful lot about wanting to reform the Fed. He clearly thinks some of the actions that occurred during the financial crisis when you were at the institution really kind of overstepped the mark and strayed into territory that was better left to fiscal authorities. What do you think of Besent's influence over the Fed and some of the ideas that he's had for reform? I don't know of the specific ideas he's had for reform. Now, I did read Scott Besent's piece in international economy in which he attacked what I voted for in 2008 and 2009 as gain-of-function monetary policy that went beyond the Fed's remit. I strongly disagree with that, of course. I think what we did in 2008 and 2009 was absolutely necessary to prevent a much deeper recession, a depression that might have happened as a consequence of the freezing up of financial markets in the fall of 2008. I think they were within the authorities, the Fed has in a natural extension of the usual kinds of things we do. I didn't see that as gain-of-function and the purchases of securities in the fall of 2008 were to stabilize the market. That's certainly a very important function for the Federal Reserve to have stable financial markets. Then, in 2009, when we extended from MBS to Treasuries to encourage a rapid recovery from the recession. That was a situation in which our interest rates were at zero. We wanted to ease policy further. We bought securities out the yield curve to lower long-term interest rates. I view those purchases as a natural extension of our interest rate power. I strongly disagree with the Secretary on that. On the other hand, what Scott Bessett does, he understands financial markets. He came from that background. He's a smart guy, obviously. If he were to be the Fed Chair, I think that he would recognize the resources he had in the staff and recognize the necessity for using unusual policies and unusual situations and back off his gain-of-function rhetoric. We believe, as well, that Bessett was quite disturbed by the development over the weekend, too. Although he's not said publicly the sense that there's been a media report that he was opposed to the decision to pursue a DOJ probe against power. So some moderating influence on the White House, perhaps. You mentioned the crisis area. I mean, someone who went through that with he was Kevin Warsh, who, of course, is in the race to succeed power. How do you feel about his candidacy and also the sense in which he's disowned some of the measures he, like you voted for, while he was a governor at the Fed during the financial crisis? So I know Kevin pretty well or got to know him pretty well. We did work very closely together through the financial crisis. His office was next to mine. He had the experience in financial markets, he could interpret what was going on. This is a guy with very high emotional intelligence. I've never seen anyone read a room as well as Kevin can read a room. Having said all that, I disagree with a lot of the criticisms that he's made of the Federal Reserve and the really personal attacks on J. Powell. I find Kevin's criticisms to be very personal to distort what happened to some extent. I mean, for example, he said the Fed keeps shifting their inflation targets. The Fed hasn't shifted their inflation target at all. They're looking at different measures of inflation to try and predict the future. And he's been very critical of the Fed's moving into areas that he says weren't part of their things in climate change and DEI, for example, in which they were basically following the Biden administration, as they're now following the Trump administration. So I think there's some validity to what he says, but not as much as he thinks. I think when he gets there, because he's been inside the institution, I think he respects a lot of the people on the staff, but not all of them. I worry that he's talking about breaking heads when he gets inside the institution. I don't know what he'd do, but he has been opposed to QE, a reluctant vote in favor in 2009, and particularly in 2010, and pretty much a hard money guy. So Donald Trump would have to think very hard about what he might be getting with Kevin Warsh. I would expect him not to change his views on the importance of price stability and fighting inflation. So we'll see. We're going to take a short break, but when we come back, I'll be asking Don about whether low interest rates would actually benefit America and discuss the upcoming Supreme Court case against Lisa Cook and what that could mean for the future of the Fed. And we're back. Don Trump has said that whoever he picks as Fed Chair needs to be able to deliver on his wish of drastically lower interest rates. All of the candidates have said they are willing to cut rates. If you were the new Chair, is there any economic rationale you could give for making rate cuts? So Claire, I think if I was looking for a rationale to cut rates, four to five months from now when the new Chair comes in, I think the rationale would have to be that we've seen the price bump from tariffs, that inflation X tariffs as coming back to 2%, and inflation expectations longer term inflation expectations remain anchored. And I think if I were coming in as the new Chair with this argument, I would hope that there be some indication in the price data that indeed inflation was beginning to come down as the tariff effects were off, and that the labor market continued to be kind of tepid, producing jobs, unemployment rate bouncing around vacancies are been low, so under those circumstances you could make the argument that at least some reduction in rates might be called for. Now, I would be talking about edging rates lower, not the drastic cuts that Donald Trump wants. I don't think there's any argument for cutting short-term interest rates to 1%. A lot of the candidates to replace Powell, and I mean, indeed, for a few people on the board, as well seem pretty optimistic on the US economy, particularly on productivity, that there be a kind of AI, generative AI induced kind of boom. How much do you share that enthusiasm on what are the repercussions of that for interest rates? Well, I think the productivity developments already have been interesting. Like most economists saw productivity before COVID, as along one and a quarter, one and a half percent track. Since COVID, since the end of 2019, productivity has grown about 2%. And I think that's before AI has really kicked in. I mean, if I see those reports of how many businesses are using and how fast it's growing, most businesses do not report a noticeable increase in productivity from using AI. I do think it's possible. I've seen estimates that it could add a half a percent to productivity growth, so maybe at least validating that 2%, that would be huge. That would be really helpful to increasing real incomes in the United States. So I think my mind is open about how much this is going to help. It's interesting to me that the Federal Reserve Survey of Economic Projections, there's been no movement in the long-term growth estimates. They remain 1.8, but that could be slightly stronger productivity offsetting a reduction in labor force growth because of the immigration situation. But I think that the Fed needs to recognize that productivity could be stronger. Unit labor costs, the four quarters leading up to Q3, I think we're like one and a half percent. So if I were making the argument, you wanted me to make earlier about why to reduce interest rates, unit labor costs would be one of the points I would make. Business costs are going up less than 2% a year. That's something that Alan Greenspan leaned on very heavily in the second half of the 1990s. There was a pickup in productivity growth, which she recognized, was reflected in the press unit labor cost that meant that there were downward pressures on inflation and he could take the productivity in higher growth and lower unemployment. So it's an important factor paying into future monetary policy. Well, absolutely. I mean, you brought up the Greenspan era. I mean, what's your recollection of that period, how much of a big issue was that in the FOMC debates in that era? You were seeing this productivity boom? It was a big issue. There were skeptics on the Federal Reserve Board who went to Greenspan somewhere there and said, "I think we need to raise interest rates on employment rates low. We think there'll be upward pressure on prices. We need to get ahead of this." And Greensman said, "No, don't worry. We've got this productivity thing going that you conventional economists haven't recognized yet." But I see in earnings forecasts and financial markets in corporate productivity growth, which was better measured than the rest of the productivity. So it was a big issue and it was one in which goes back to the leadership thing. Alan Greenspan, citing data, doing analysis with staff, showing that analysis to the FOMC, convinced the FOMC that he was seeing something that other people weren't, and that that should affect the path of monetary policy. And he was charismatic. I don't think Charisma is. I don't see Alan Greenspan as charismatic. I see him as relentlessly rational and, you know, he marshalled his arguments. And his arguments were unusual sometimes. I used to kid him that he could take one odd number that no one had any confidence and divided by another weird number that no one had any confidence in and come up with a result that sometimes gave us insight into where the economy was going. But he was a data maven for sure. Your comment is interesting because it wasn't Alan Greenspan's charisma that captured the rest of the committee was the fact that he was right and could back his arguments with data. That's a cracking insight from the Greenspan era, bringing it back to the present day. Later this month, the Supreme Court is going to hear arguments on the Lisa Cook case. How important is the result of this case for Fed independence, do you think? I think it's very important, it's crucial. I mean, what the Trump administration has tried to do here is to take what at worst is a misdemeanor from the past and use it to unseat a governor. Congress said a governor can be unseated only for cause. The Trump administration is trying to define down that cause. So they're trying to make it very easy to fire people they don't agree with. I hope that the Supreme Court sees through this and doesn't lower the four cause definition so low that a parking ticket two decades ago can get you thrown off the Federal Reserve Board today. I think if they don't make that clear, then the president will be looking for any little infraction in all the governor's past and using that to dismiss him. So I think it would undercut independence very badly. The sense we've got from Cook and from Powell too is that they're willing to take on the administration. Have Cook and Powell created a bit of a playbook by which you'd expect other governors to respond to the sort of pressure we've seen on them? Yes. Now I think it's challenging. I know when I was on the board of governors, I didn't have a huge amount of resources to hire high price lawyers of someone had. And I think Lisa Cook is getting pro bono works. So I hope that the legal profession would see that the welfare of the country depends on resisting this kind of thing. And for people like Lisa Cook or Tom Cohn, when he was on the board, they would provide a good part of the legal advice pro bono. But I do think they've got a playbook here that I would expect other governors to follow. And do you have any sense of what you think the outcome of both the Supreme Court case and the investigation into Powell will be? So I think the investigation into Powell will be a big nothing burger. So I don't think there's anything there. Jay Powell is as straight an arrow upright. I almost said uptight, but I meant upright. Guy, so I'm confident he did not lie to Congress. He gave the information as he knew it when he knew it had there was no intent to deceive Congress. I'm completely confident that there's nothing there. I think the key here is the Lisa Cook thing. So if the Supreme Court does what I hope they do and keeps that for cause being a real hurdle, a real barrier to firing, I think that'll be really important. And just to be clear to listeners, both Lisa Cook and Powell have denied the allegations against them. So other than don't do it, what would your words of advice be for the next venture? I would say follow in the footsteps of Paul Volker, Alan Greenspan, Ben Bernanke, Janet Yellen, and Jay Powell. Look at the goals for the Federal Reserve. Use the best possible analysis and data to figure out where the economy was going relative to those goals. I argue for and convince your colleagues that your vision of where the economy is going and what interest needs to be to get it there is the right one. Use the staff wisely. There's just a huge amount of intellectual firepower on that staff that doesn't mean there are no changes that should be made. You need to be comfortable with the people you're working with, but recognize what you've got. And carry on in this tradition, really, that's a bird. Since Arthur Burns left the Federal Reserve and the lessons of the 1970s were learned. Very good. Don, thanks so much for joining us. Thank you Claire for having me on. It's been a very good conversation. I'm sorry that some of the subjects came up, but we didn't make them come up. The President made them come up. For this week, you've been listening to the economics show from the Financial Times. This episode was produced by Misha Frankl Duval, with original music by Brin Turner and sound engineering from Samantha Geovinco. The broadcast engineer is Andrew Jojadas. The executive producer is Manuel Saragosa. I'm Claire Jones. Thanks for listening.