Rob Kaplan is completely on board with the Federal Reserve’s 25bps rate cut at its September meeting. And still applauding that the all but one member of the Board of Governors came together for this widely expected policy move instead of dissenting for a bigger 50bps reduction: “It reaffirmed my belief that indepence, political independence, is alive and well today at the Fed.”
What is less certain to the former Dallas Fed Bank president is what the FOMC - the Fed’s policy-making Federal Open Market Committee - does at its October meeting. Rob says if he had to submit his own Summary of Economic Projections - from which the Dot Plot forecast of coming interest rate moves is generated - he would have forecast only one more rate cut this year. Even then he says he would not commit to any timing or size of rate cuts now. “I want to take it one meeting at a time.”
Bottom line: he sees the headwinds to the economy that the more aggressive rate cut views are based on as emanating from tariffs, the lack of labor force growth, government spending cuts and more. “So if you’re just looking at that, and you want to buy insurance from a further downturn in the labor market, I could see why those who said ‘I want to do more’ are saying, do more.”
What about an inflation rate that is far above the Fed’s 2% target, much closer to 3%,
with tariffs threatening to push it even higher?
”I’m a beliver that the tariff increases have a good chance to be one-time price level increases, not inflationary because we’ve got giant overcapacity in goods globally,” Rob says. “Services is where we’re seeing inflation still sticky and the shortage of labor is coming up…and yeah, so I’d be reluctant” to do commit to more rate cuts now.
But isn’t Fed policy still restrictive? Should the Fed keep cutting rates to get the key policy rate back to neutral? And what about those who argue that with an economy that is still growing at a solid rate and a stock market that continues to rise, the neutral rate is probably higher than many Fed and Wall Street estimates, arguing for fewer or no rate cuts at all?
”We…are closer to neutral and we still have got an above target inflation issue,” he says. “Unless you see some demonstrable improvement in inflation, the Fed doesn’t have that many cuts to work with.”
So dive and see, hear what Rob has to say. Not only is it useful to hear him do him discuss R*, the Fed’s so-called neutral rate, it’s good to see his math on what whether Fed policy is restrictive, neutral or accommodative and why he says it shows the FOMC has to take its decisions meeting by meeting until the state of the labor market, inflation, and the economy becomes much clearer.
September cut was the right thing to do 00:01:04.040
The cut in September was the right thing to do. If I were submitting my SEP. I would have called for cuts this fall, not 3. But when I look at the scatter… so I understand why, I think it was 7 said 1 more… said, nothing more, 2 said 1 more, 9 or 10 said 2 more… fine. And it's understandable.
An economic debate 00:01:31.660
Rob Kaplan: There are… there's a debate going on, it will get resolved with the passage of time, in that the economy itself is sluggish, weak, not falling off a cliff, based on all my work with businesses, but sluggish. And the labor market, sluggish to weak. Having said that, there's a whole range of tailwinds coming. Tax incentives, regulatory review, AI, Data center, power boom. That make you think that growth may accelerate. However… It'd be easier for growth to accelerate if you had more labor force growth than what we have. But we'll get to that as we talk. But they'll debate these cross-currents in the weeks ahead, but I think this was the right move for the September meeting.
Only one dissent 00:02:58.
I was gratified, no matter where you were in the debate, by and large, people decided, let's come together, and that's why I only saw one dissent. I thought that was… that was excellent, and I was very impressed. And it reaffirmed my belief that independence, political independence, is alive and well today at the Fed. Now, as to why the spread, I understand that too.
Headwinds battle tailwinds 00:03:25.910
If you were just focused on the economy as we see it right now. There's a headwind from tariffs. There's a… there's a headwind from the transition from government spending directed fiscal policy to more organic tax incentives, which are coming, but the tax… the cost cuts…You know, Medicaid reimbursement as an example. Some of the other spending cuts probably are a headwind, and then the lack of labor force growth is a headwind, and what people don't realize is there's… there's a multiplier effect.
If a… Window installer job, or construction job, or some other job goes unfilled. there's a half-to-one job that you would have created in a restaurant or something else in the community that you don't get, so… If you're just looking at that, and you want to buy insurance from a downturn further in the labor market, I could see why those who said, I want to do more, are saying do more. But on the other hand, as I said earlier, AI boom, power center boom, data center boom, regulatory review… Stock market is pricing on these tailwinds over the next 2 or 3 years. The economy and the stock market are going to converge.
Either the… either the economy's going to get stronger, or the stock market's going to get weaker. My guess it'll… my guess is it's going to be… some of it's going to be the economy's going to get stronger, and you want to be careful how many rate cuts you're committing to, and that… so I understood those who said, I'd rather not commit to any more, I want to take it one… that doesn't mean they won't cut, by the way, but they're just saying, I don't want to forward commit, I want to take it one meeting at a time. So I understand the… the debate
Economic cross current, issues, but limited weakness 00:05:39.290
I don't hear from businesses that business has fallen off a cliff. What I hear about is sluggishness and uncertainty for various reasons. That doesn't feel to me like an environment where you're going to start getting Big, unemployment jumps. Okay, and obviously we don't have supply, but even before that, I think business is solid. We have a matching problem in the employment market, and there are a lot of open jobs. However, there's a lot of people looking for jobs who don't want those jobs, okay? College graduates don't want to work in construction or be a window installer, and so we've got some mismatches to work through, but we will.
The inflation worry is from the services sector 00:06:22.480
Rob Kaplan: And on the same time, there's reason to believe, the thing that worries me on the inflation front, and you should be worried, everybody thinks, well, you're overreacting to the tariffs. This isn't about the tariffs. Goods have been disinflating, okay? And I'm a believer that, the tariff increases have a good chance to be one-time price level increases, not inflationary, because we've got giant overcapacity in goods globally. And AI, is also disinflationary. The thing that I would guess worries people, the Fed, is services. Services is where we're seeing still inflation sticky, and where the shortage of labor is coming up. Obviously, rents are a factor. And so, yeah, I'd be… I'd be reluctant. I don't want… I… I… so then that gets me to where are we on restrictive versus neutral versus accommodative?
The neutral rate…what should Fed funds be? 00:07:36.610
So the funny thing about the neutral rate, on the one hand, it's imprecise, and it's theoretical.
But you've got to take a stab at it, despite that. And I always felt that at the Fed, and I feel that now. So let's take our stab. Inflation is 2 ¾ , okay? Now, if I'm wrong, it's 3. So, let's be aggressive. It's 2 ¾ . The real Fed funds rate, and I've done a lot of work on this, you remember Evan Koenig, we did an enormous amount of work over the years about what's the real neutral rate. My guess is if you want to be aggressive, it's ¾%. I think some people at the Fed think it's closer to 1%. Let's be aggressive. ¾%. That gets you to a neutral nominal rate right now. Of 3.5%. Okay? It's very difficult for me to muster an argument why it should be lower than 3.5%. I could see why some people think it should be a little higher, but I don't see why it should be lower. You would need inflation to improve – or to have demonstrated it's on the path to improve, to think it was lower than 3.5. So where are we right now? We're at 4% - 4.25% on Fed funds.. With inflation above target, I’m just worried about inflation. I don't want to get <Fed funds> to neutral. I'd like to be slightly restrictive. So what's that mean? 3 ¾%, maybe. We don't have a lot of room. We're already at 4% to 4.25%. Now, if the labor market really weakened further, then I could argue, yeah, alright, let's get to neutral. I don't know if we should be accommodative, but let's get to neutral. But…
The Fed is now closer to done- not much room as things stand 00:09:14.640
But we're not that far from neutral. So my point is, a year ago, people say, but you cut 50 a year ago. Well, yeah, the Fed funds rate was 5.25%, 5.5%. In my view, we had 175-plus basis points of room, it wasn't that hard a decision for me to say 50 in September was the right thing. we're now 100 basis points, now 125 lower. We don't have <the same room>… we're closer to neutral, and we've still got an above-target inflation issue. So I think… unless you see some improvement, or demonstrable improvement in inflation. Fed doesn't have that many cuts to work with.
So, what about job growth? a can of worms… 00:11:48.670 Look at… let's look at the trend, and let's look at other indices. And by the way, it's not a mistake to look at other private indices, too. And don't bet the ranch on those, either. They're all imprecise, because they all… there's no getting around. In an economy where a lot of the labor… the job growth is in small business. You know, don't beat up the BLS. How are you supposed to get at these small businesses and find out? And also, they make assumptions. About how many workers a new business, this birth-death assumption, how many workers work in a new business? The truth is, with the gig economy, the number of workers are lower in a new business. And so, he gave me all these caveats, and what we learned is, look at the whole mosaic.
The Fed Talks to Businesses as well 00:12:35.000
That's why we talk to businesses, that's why we look at structural drivers. And so, to your point, we've also known for a number of years that probably the assumption about the number of workers associated with a new business was too high. It was backward-looking, and it was too high. And so, the current revision down was… should not have been a shocker to people. A number of economists I talked to expected a downward revision, but had been expecting it for months. Okay? So, I think the trend is still the thing to watch, but here's the other thing to watch. What are businesses saying, and what's happening to revenues? What's happening to business? What's happening to sales? And, on that, what I hear from, again, businesses is.
The American consumer is upper tier 00:13:23.280
If you deal with low-moderate-income consumers, boy, they're stretched. They're spending, but they're… and that's 80 million workers make 50 grand a year or less. Man, they're… they're under stress. There's another 80 million consumers who are 55 and older, own their home, have financial assets, more affluent, and they're spending, and they're doing… and they've got financial assets, stock market's up, and they're doing fine. And that's why you saw this statistic recently. That a very large percentage of consumer spending is coming from the affluent.Okay? That's not new news, that's… but that's what's going on out there. So that's… you could imagine why it's confusing.
Skills mismatch problems 00:14:08.070
And then you've got these skills mismatches, in that there are a bunch of open jobs. and they can't find workers, and yet, on college campuses, it's been a terrible recruiting year for college graduates. So how do you square all this? Well, it's because those college graduates don't want the jobs that are open, even though they're good jobs, they're great jobs, but that's not what… why they went to college. They thought they were going to be computer programmers. Turns out the world, I can tell you, in the businesses I work in and with, we don't need as many programmers. We don't need as many analytical people. We still need salespeople.We need lots of other things. We need also skilled labor, and so I think these mismatches make this job growth and hiring somewhat confusing to interpret. And so, what do you do when that happens? Just slow it up.Take a one meeting at a time. look at the broad mosaic, not just the data, and I think that's what they're trying to do.
Fiscal challenges 00:16:25.560
So, the deficit, we'll see what's going to run, but t looks like it could run $2 trillion plus again this year.Now, what would make it a little bit better? The stock market's up, so maybe there'll be more tax revenue from gains from the stock market. But otherwise, we're running big deficits. We started the year thinking we were going to have Doge, and we were going to restrict spending, and it just hasn't materialized. the way we thought. I think the administration then has pivoted on tariffs. from… from the strategy part of it to, we want more revenue, and that's the reason why I would argue they've been… they've been tougher about keeping tariffs at higher levels, and they've been slow to make a deal, which I think they thought, going into the year, they might make with Canada and Mexico, because that's how you domicile here. Cheap. goods from Canada, materials, and cheap labor. The problem with tariffs is they slow… they slow growth. It's not popular to say, but they slow growth, and so for every dollar you get, you give back part of it in less tax revenue. And we're seeing slower growth. Also, the workforce curtailment, as I said earlier, is slowing growth. This administration, I would, is aware of that.
Financial signalling 00:17:42.640
So, what's happening? Two warning signs. The term premium on the 10-year and beyond is up. But the big one, Dollars down 10% plus year-to-date. But gold is up 35% plus in dollar terms. That's been, I think, since the late 70s was the last time gold went like this. That's a warning sign. What does that tell you? It tells you they're not looking at the 10-year as a safe haven as much. Maybe gold. For some, maybe Bitcoin. Other assets… And so the… I know, and you're listening to Scott Bessant, he… he… they've shortened maturities. They were critical of the last administration for shortening maturities, but they realized, I don't blame them, they had to. But he'd like to be able… he hopes stablecoin will help shore up a little bit of front-end demand, you know, stablecoin will be backed by short-term treasuries, but they want to make progress on the deficit. There's only one way to do it. You could do more spending cuts, but there's one other way. You got to grow faster. We can't keep growing at 1.5% and deleverage. We've got to be growing at 2% plus.
How to do it? What to do? 00:18:55.180
And so I would argue that regulatory review, we'll see whether they do some amendments on what they're doing on the workforce to help stimulate growth. They're facilitating the AI-powered data center semiconductor boom to fuel more productivity growth. And, and honestly. I think the pressure a little bit, they'd like to see rates lower, because it will help… it will help growth. It may, unfortunately, stoke inflation, but it will help growth. And right now, I think they're thinking, over the next year, year and a half. We want to get growth higher. It'll help us deleverage, it'll help us keep more of the tariffs net. And also, I don't need to get into this, but there's an election I've read in November of 2026. This all will fit together better.If there's higher growth.
2% IS the RIGHT Target 00:21:57.790
I think we've learned, I would think we've learned in the last 3 or 4 years, inflation is very unpopular because it squeezes that group, and it makes wealth and income inequality. I don't know… I think it would be a mistake to let go of the 2% target. I don't… I don't think… I think most people at the Fed, I would hope they're not going to, but this may be part of the debate implicitly, why you see one side and the other there, but I would be an advocate if I were there. We've got to get to 2%, because the effect it has on low-moderate income
The Fed needs independence…and limits 00:26:19.740
The Fed should retain political independence and have emergency powers in a crisis to use its balance sheet, but not But the bar's been too low to roll out this balance sheet when it wasn't emergency… in COVID, it was an emergency. A year after COVID, not an emergency. Should have been rolled back, in my opinion, and I was saying that at the time. So, I think there's issues to be discussed about this subject.
What independence is… 00:28:56.450
Here's what I think. I think it's essential that in… your deliberations as a member of the FOMC, either as a president or governor, that you make your determination based, without regard to political influence or political considerations. And make the best judgment you can… and are not looking over your shoulder that you could get fired.
ROB KAPLAN
Rob Kaplan is Vice Chairman of Goldman Sachs and a member of the Management Committee. Previously, Mr. Kaplan served as President and CEO of the Federal Reserve Bank of Dallas. Before joining the Fed, he was the Martin Marshall Professor of Management Practice and Senior Associate Dean at Harvard Business School (HBS).
Mr. Kaplan initially joined Goldman Sachs in 1983 and became a Partner in 1990. In 2002, he became Vice Chairman of the firm with global responsibility for the Investment Banking and Investment Management Divisions. He also served as Co-Chair of the Partnership Committee and Chair of the Goldman Sachs Pine Street Leadership Program. In 1998, Mr. Kaplan became Global Co-Head of Investment Banking and a member of the Management Committee. His previous roles included serving as Head of Asia Pacific Investment Banking, Co-Chief operating officer of global Investment Banking and Head of the Americas Corporate Finance Department.
Mr. Kaplan retired from the firm in 2006 to join HBS, becoming a Senior Director at that time.
Mr. Kaplan is Chairman of Project ALS and Co-Chairman of the Draper Richards Kaplan Foundation. He is a board member of Harvard Medical School and St. Mark’s School of Texas, and is a member of the George W. Bush Institute’s Advisory Council. He is also an Advisory Board member of the Baker Institute. He serves on the Bipartisan Policy Center President’s Council and on the Board of Directors at The Holdsworth Center.
Mr. Kaplan is the author of three books on leadership, What You Really Need to Lead, What You’re Really Meant To Do, and What to Ask the Person in the Mirror.
