Higher For Longer | Robert Kaplan, Former Dallas Fed President & CEO

Episode Summary

Executive Summary: Robert Kaplan argued the Fed should pause in June but keep policy tight longer, warning that forward guidance in 2020 boxed the Fed into prolonged accommodation, worsening inflation and contributing to bank stress. He sees fiscal spending, sticky services inflation, and housing dynamics keeping growth and prices firmer than markets expect, while regional banks face ongoing deposit pressure, lower capital, and tighter lending.

Main Topics: Fed policy, the June meeting, and higher-for-longer rates (Priority: 5/5): Kaplan said he would prefer the Fed pause at the June meeting while explicitly signaling that the pause remains within a tightening stance and that more hikes could follow. He believes markets are too aggressive in pricing cuts by year-end and expects rates to stay elevated longer to combat sticky inflation. 2020 forward guidance and the inflation overshoot (Priority: 5/5): He dissented from the Fed's September 2020 framework because it effectively promised zero rates until full employment, despite inflation already at or above target. He argued that rigid commitments reduced flexibility and helped prolong asset purchases into 2021 and 2022, contributing to later inflation problems. Banking stress, asset-liability mismatches, and supervision (Priority: 5/5): Kaplan said the banking turmoil was not solely caused by rate hikes, but by banks' large maturity mismatches, uninsured deposit exposure, and inadequate supervision. He argued regulators should have forced vulnerable banks to de-risk earlier and that the system now has less capital than widely believed. Credit tightening and the coming credit cycle (Priority: 4/5): He described the current banking situation as a 'dull headache' rather than a crisis, but said banks are tightening lending, especially to small and midsize businesses. He expects earnings pressure, higher loan reserves, and continued caution as the credit cycle develops. Fiscal policy still offsetting monetary tightening (Priority: 4/5): Kaplan argued that residual pandemic-era fiscal programs, plus the Inflation Reduction Act and Infrastructure Act, are still supporting demand in 2023 and 2024. He believes this fiscal tailwind is helping explain why the economy has not slowed as much as the Fed expected. Inflation, housing, and low-income wage pressure (Priority: 4/5): He said service-sector inflation is stickier than markets assume, nominal growth remains too high, and housing is still stimulative because many homeowners locked in very low mortgage rates. He also pointed to wage pressure among workers making $50,000 or less as a source of ongoing price stickiness. Role of policy beyond the Fed and venture philanthropy (Priority: 3/5): Kaplan stressed that monetary policy alone cannot solve inflation and urged a broader policy mix including energy and fiscal policy. He closed by discussing Draper Richards Kaplan Foundation, saying social entrepreneurship is increasingly important amid venture market stress.

Key Arguments: The June FOMC should likely pause, but the Fed must clearly communicate that the pause is still within a tightening regime, leaving room for additional hikes if needed. Kaplan's 2020 dissent was rooted in opposition to a binding promise of zero rates until full employment when inflation was already at/above target. Forward guidance in 2020-2021 constrained Fed flexibility and helped keep bond-buying and accommodation in place too long. Bank failures were driven not just by rate increases, but by concentration risk, asset-liability mismatches, and supervisory inaction. Regional banks are now facing higher deposit costs, lower mark-to-market capital, and reduced willingness to lend, which especially hurts small and midsize businesses. The current banking situation is not a full crisis, but it is enough to constrain credit and pressure bank earnings. Fiscal spending from pandemic-era and newer federal programs is still working through the economy and cushioning the effect of rate hikes. Services inflation and wage pressure among lower-income workers suggest inflation will be stickier than the market expects. The Fed should not look only at equities; credit spreads, bank lending, and credit availability are more important signals. Monetary policy should be complemented by fiscal and energy policy, because the Fed cannot solve inflation alone.

Data Points: Fed funds rate: 5.0%-5.25% - Kaplan described the current policy rate level and said the Fed may need to do a little more. Rate hikes since tightening cycle began: 500 basis points - He referred to the Fed's rapid increase in rates from near zero. Fed asset purchases in 2021: $80 billion Treasuries + $40 billion MBS per month - He said the Fed kept buying bonds at this pace through 2021 and much of 2022. Fed asset purchases in 2020: $120 billion per month - He noted the Fed was monetizing/facilitating stimulus during the COVID crisis. Nominal GDP growth in 2021: 12% - He used this to argue the economy was overheating. Current nominal GDP growth: About 7%-8% - He said growth is still too strong for inflation to fall much further. Target nominal growth needed for lower inflation: Around 4%-5% - He said inflation below 3% is hard without nominal growth near this range. Potential real GDP growth: About 2% - He tied this to U.S. long-run growth capacity. March 2020 GDP decline: About 30% month-over-month - He described the initial COVID shutdown shock. April 2020 GDP rebound: About 30% month-over-month - He described the reopening rebound. 2020 annual GDP loss: About 7%-8% - He summarized the full-year contraction. Home mortgage rates: About 6.25%-7% - He said higher mortgage rates are squeezing first-time buyers. Low-rate mortgages locked in during easing: About 2.8%-2.9% - He cited homeowners who refinanced or bought at historically low fixed rates. Workers earning $50,000 or less: About 50 million - He identified this group as facing persistent wage/price pressure. Venture philanthropy fund size: About $90 million - He described Draper Richards Kaplan Foundation's capital base. Foundation donors: About 85 donors - He noted the base supporting the nonprofit venture fund. Annual social enterprises backed: 20 to 25 - He said the foundation supports this many early-stage organizations each year. Venture portfolio over time: Over 200 ventures in 12-13 years - He described the foundation's track record.

Pivotal Quotes: "I would not act in this meeting, but I would make clear that the pause is within a tightening stance, which means there might be more increases after this meeting." — Robert Kaplan: His view on the June FOMC meeting and how the Fed should communicate "We were running 120 miles an hour... but after we got out of the ditch... it would have been smart to take your foot off the accelerator and start going 55 miles an hour again." — Robert Kaplan: His analogy for why the Fed should have withdrawn accommodation sooner in 2021 "The banking system has less capital than we would have thought." — Robert Kaplan: His assessment of the post-SVB regional banking environment

Implications: Expect higher-for-longer rates, continued credit tightening, and slower loan growth for smaller firms. Inflation may stay stickier than markets price, while bank supervision, deposit behavior, and fiscal offsets remain key risks to watch.