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Global Perspectives: Tom Hoenig on the Costs of COVID-19, Modern Monetary Theory and Fed Leadership

Mark A. Wynne

April 28, 2020

Tom Hoenig served as the eighth president and chief executive officer of the Federal Reserve Bank of Kansas City from 1991 to 2011. Upon retirement from that role, he joined the board of the Federal Deposit Insurance Corp., serving as vice chair from 2012 to 2018. He is currently a distinguished senior fellow at the Mercatus Center at George Mason University, where he studies the long-term impact of the politicization of financial services, as well as the effects of government grants and privileges on market performance.

Hoenig began his career as a financial economist at the Kansas City Fed and subsequently held senior positions in banking supervision. He earned his PhD in economics from Iowa State University.

The Federal Reserve Bank of Dallas recently hosted Hoenig as part of the Bank’s Global Perspectives speaker series. This series was launched at the beginning of 2016 with the objective of bringing leaders from the worlds of business, academia and policymaking to the Dallas Fed to share their insights on global, national and regional developments. The April 14 event was the first Global Perspectives virtual event without an audience present—a result of the COVID-19 pandemic and social distancing measures.

Hoenig and Dallas Fed President Rob Kaplan discussed Hoenig’s views on the costs of the current crisis, potential solutions and the elements of effective leadership at the Fed. The following are excerpts from their conversation, edited for clarity and presented by topic.


On the Cost of the COVID-19 Crisis:

Hoenig: My judgment is, it will be worse, easily worse than the global financial crisis a decade ago. I've seen the IMF [International Monetary Fund] estimates of global GDP [gross domestic product] falling 3 percent this year. That's revised from an earlier projection of 3 percent growth—for a 6-percentage-point swing. When you think of the speed with which the unemployment rate is increasing—the surge in initial claims—this is going to be more difficult.

In terms of cost, we already know that the Treasury is increasing spending dramatically. We know we're going to have at least a $3 trillion deficit. That's a cost. Our spending will go from $5 trillion, with $1 trillion borrowed, to $8–$9 trillion, with $3–$4 trillion borrowed. It's going to be expensive to come out of this, and it will take time.

I think one of the challenges ahead will be how we manage that debt and how we contain the negative effects from that debt through the next decade. Remember that the debt in 2010 started at about $11 trillion. A year ago, it was $22 trillion, next year or the year after it will be $30 trillion. When you have this level of debt, it could lead to pressure on the Federal Reserve to keep interest rates down because of the cost of carrying this debt. If interest rates were to go up, it would be horrendous.

We have some enormous challenges ahead of us, which we can handle, because No. 1, we are still the greatest industrial country in the world. But that doesn't happen by itself; we're going to have to do some very careful thinking and make some very careful policy decisions, and I think that will be a major challenge for the times.

On Modern Monetary Theory as a Solution:

Some of us have heard of the so-called Modern Monetary Theory, where you can solve everything by just printing money and doing fiscal policy. That's going to be a challenge. There will be a lot of people who say, ‘Hey, we did it. We printed all this money. Let's do it some more, we’ll be fine.’ The outcomes of that could be very, very negative.

The issue over time will be, if you print this money, you monetize the debt. That means the Federal Reserve is putting that debt on its balance sheet to keep it from recirculating into the economy. The Fed is going to have to pay interest on those excess reserves to keep them sterile, keep them out of the economy, so that you don't invite inflationary pressures.

And then there will be the argument that, as long as you can print money, you can handle the debt, and if you do get inflation, you can address it by cutting back on fiscal spending. I think that will be very, very difficult. It sounds great in theory, but in practice it's a significant challenge. As you continue to build the debt, you continue to put enormous pressure on the central bank to buy that debt either directly or indirectly. To keep it [new cash] from recirculating into the economy causing inflation, you have to pay interest on those reserves.

It becomes kind of its own vicious circle until finally something gives, and it probably would be either another financial crisis where asset values suddenly collapse because of the weight of so much money being out there and finally people losing confidence. Or, it would be a very strong inflationary cycle that no one anticipates right now but that could easily surface. We’re not immune from it. We know that from the period of the ‘70s, and we shouldn’t take it for granted.

On Low Interest Rates and Reaching for Yield:

I think the last decade of suppressed rates has not served savers well. Now, one response to that is the fact that during the decade, the stock market was doing well. I understand that. But the fundamentals of saving, the fundamentals of pension funds, have been eroded. Pension funds in the United States are heavily underfunded in some instances because of these very suppressed rates, and they [pension funds] are not in a position to necessarily go to high-risk assets.

So, there has been a subsidization by the saver to the debtor that has caused some misallocation of resources, some maldistribution of wealth, and I don’t think we should deny that. I think we should take a look at it. I fully understand why we were willing to take actions in the last crisis necessary to bring us out of that. But we need to let the economy run as an economy should, with savers and investors providing the necessary fuel and going forward to invest in productive goods, and then I think we would be better off in the long run.

Right now, we are in a crisis, and we have to do what is necessary to get through this crisis. I spent a decade talking long term, and tonight I’m telling you, ‘We have to think long term.’ We really have to get through this and then think about how to encourage investment, encourage productivity. I think that’s where the interest should be.

On What Makes a Good Federal Reserve Chair:

I think the most important thing that you have to have as Chair is the ability to listen and understand. That means you have to have some training in the areas of banking and finance. I don’t think by any means you have to be an economist. You just have to have the necessary background. But more importantly is the ability to listen and to understand. A lot of people think they know the answer and then, if they fail to listen, they miss very important points.

Then, of course, there is the ability to actually make a decision. There are a lot of smart people out there, but if they can’t make a decision, nothing gets done. So, the final part of it is the courage to make a decision when there is a great deal of uncertainty around that decision because no one has perfect knowledge. If you did, it wouldn’t be a hard decision at all. But most decisions are difficult. We don’t have all the information. That’s why you listen. You think about it, you use your experience, and then you decide and you act.

On What Makes an Excellent Federal Reserve Bank President:

The same things make for an effective reserve bank president [as a Fed Chair] because you have to run a big operation. There is a lot of money that flows through the organization, and there is a lot of supervision that takes place. There is a payment system that’s changing rapidly.

Those are all necessary ingredients for running that operation. We have to have the additional, what I call interpersonal skills because you work with 11 other presidents and, under normal times, seven governors, one of them being Chairman of the Federal Reserve.

About the Author

Mark A. Wynne

Wynne is vice president and associate director of research in the Research Department at the Federal Reserve Bank of Dallas.

The views expressed are those of the author and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.

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