142 – Donald Kohn on Fed Policy from the 1970s to Today

Episode Summary

Executive Summary: Donald Cohn reflects on four decades at the Fed, covering the Great Inflation, Volcker’s disinflation, Greenspan’s data-driven policymaking, the 2007-09 crisis, and current Fed strategy. He argues that price stability, clear communication, and stronger macroprudential policy remain central, while the Fed must prepare for the zero lower bound with credible unconventional tools and careful risk management.

Main Topics: The Great Inflation and Arthur Burns (Priority: 5/5): Cohn describes joining the Board during the 1970s inflation surge, portraying Burns as highly demanding but ultimately unwilling to take the decisive actions needed to restore price stability. Volcker’s disinflation and political pressure (Priority: 5/5): He recounts the intense social, political, and financial backlash to Volcker’s tight policy, emphasizing the courage required to break inflation and anchor expectations. Greenspan, productivity, and data interpretation (Priority: 4/5): Cohn explains how Greenspan used detailed statistical analysis to detect a productivity revival before it was obvious in aggregate data, and how that shaped policy debates. Transition from staffer to governor and vice chair (Priority: 4/5): He highlights the shift from internal analysis to public accountability, noting the need to explain policy to Congress, markets, and the broader public. The 2007-09 financial crisis response (Priority: 5/5): Cohn recounts the Fed’s efforts to address funding market stress, discount-window stigma, the creation of the TAF, and the challenge of making policy amid foggy and lagged data. Future Fed strategy: zero lower bound, tools, and communication (Priority: 5/5): He supports flexible inflation targeting, possible negative rates, unconventional tools, stronger macroprudential buffers, and simpler communication to improve public understanding.

Key Arguments: The 1970s inflation was not just a data problem; policymakers saw rising inflation and should have questioned their assumptions faster when policy was not working. Volcker proved that a central bank can achieve price stability if it is willing to take decisive action, even at great short-term economic cost. Greenspan’s edge came from digging beneath noisy aggregate statistics to read underlying productivity and profit trends better than many skeptics. The move from staff to governor changes everything because the policymaker must own decisions publicly and defend them to Congress and markets. The 2007-09 crisis showed that liquidity facilities matter, but stigma can prevent effective use of the discount window, requiring redesign like the TAF. The Fed needs a clearer playbook for future zero-lower-bound episodes, including forward guidance, QE, and possibly negative rates or incentive schemes. Raising the inflation target to 4% is not a good answer because it conflicts with the price-stability mandate and would weaken credibility. Macroprudential tools, especially capital buffers built in good times, can reduce the odds that financial shocks turn into deep recessions. The Fed should communicate in plainer English because poor explanation can erode confidence even when policy actions are effective.

Data Points: Years at Kansas City Fed: 1970-1975 - Cohn’s early career before joining the Board of Governors Years at Board of Governors as staffer: 1975 onward - He arrived during Arthur Burns’s chairmanship Volcker-era unemployment peak: about 10% - Unemployment rose sharply during the disinflation recession Federal funds rate peak: 20-22% - Tight monetary policy in the early 1980s pushed rates to extreme levels Fed target disclosure timing: early 1993 or early 1994 - Cohn recalls when the Fed began announcing its target after meetings Press conferences under Bernanke: 4 per year - Bernanke introduced quarterly press conferences to increase transparency Planned press conferences under Powell: 8 per year - Cohn notes Powell’s plan to increase frequency Bernanke chair start: February 1, 2006 - Cohn discusses becoming vice chair soon after Bernanke took office Cohn vice chair start: June 2006 - He was asked by Bernanke to serve as vice chair Credit-control intervention: 1980 - Carter administration used credit controls to try to blunt inflationary pressure TAF introduction: December 2007 - Term Auction Facility was created to reduce discount-window stigma Monetary easing in early crisis: 1.25 percentage points in one month - Rate cuts between December 2007 and January 2008 Policy response to Bear Stearns: additional 50 basis points in March 2008 - Further easing followed the March episode Equilibrium nominal rate estimate: around 3% - Cohn suggests 1% real equilibrium plus 2% inflation target Typical pre-recession nominal rate: 4%-5% before tightening - He contrasts historical room to cut rates with today’s lower starting point

Pivotal Quotes: "it was very difficult, and we knew people were suffering." — Donald Cohn: Describing the social pain and protests during Volcker’s disinflation "the job of the central bank is price stability. And from that will flow good economic performance." — Donald Cohn: Summarizing Volcker’s legacy and the Fed’s long-run mission "we didn't explain it as well as we could have and we didn't reach out as well." — Donald Cohn: Reflecting on the Fed’s communication shortcomings during the crisis

Implications: The episode reinforces that central banks need credible anti-inflation resolve, crisis-era liquidity tools, and a better crisis playbook for the zero lower bound. It also suggests public trust depends as much on explanation and transparency as on policy success.