Related Links

• Central Bank Lending Lessons from the 2023 Bank Crisis
• Charting the Path of Interest Rates
• Lubik-Matthes Natural Rate of Interest

Transcript

Tim Sablik: My guest today is Anna Kovner. Anna became the director of research at the Richmond Fed this past June. Prior to that, she spent more than 15 years at the New York Fed, most recently as the director of financial stability policy research for the Research and Statistics group. Anna, thank you very much for joining me today.

Anna Kovner: Thanks for having me on.

Sablik: So, this is our 150th episode of Speaking of the Economy, and I can't think of a better way to mark the occasion than having the opportunity to sit down and chat with you.

We're going to cover a range of topics, but I thought we could start by learning a bit more about you, Anna. As I learned from a brief chat with you earlier, you're a lifelong New Yorker and, as I mentioned at the outset, you worked at the New York Fed for more than 15 years. Can you share a bit about your background in economics and how you came to the Fed?

Kovner: I became an economics major as an undergraduate at Princeton, where I was lucky enough to have the opportunity to take classes from future Nobel Prize-winning economists, including Ben Bernanke and David Card while he was writing some of the research that earned him his Nobel Prize.

After doing that, I took what's actually kind of an unusual path to being an economist. I worked as an investment banking analyst, and then I got an MBA after that. I was working as an investor, investing in distressed debt and private equity.

I used to spend a lot of time asking questions there — why are we making money here, what's going on? There was not a lot of enthusiasm in my office for that type of inquiry. So, I applied to graduate school in economics. I had done labor economics as an undergraduate and then switched to financial economics, in some ways to take advantage of my experience on Wall Street.

After leaving my PhD program at Harvard, I joined the New York Fed, thinking about questions that related to financial intermediation. I joined the New York Fed the week before Lehman Brothers failed in 2008, and then my work shifted into macro-financial questions around financial crisis and things like that.

Sablik: And then, maybe talk about what it's been like moving to Richmond.

Kovner: Richmond has been an amazing experience for me.

First of all, it's great to have a change. You don't realize what a creature of habit you've become, so interacting with new people and new ideas [has] been tremendously stimulating.

I've also been tremendously happy with the exceptionally great restaurants I found in Richmond and the warmth of the people in Richmond. I've had the opportunity to connect with old friends from college and graduate school who hosted dinners with friends in Richmond. Even my neighbors came over and introduced themselves. I can say I lived in the same apartment building in New York for 10 years, and I don't think I ever met all of my neighbors.

Sablik: [Laughs] The restaurant thing comes up. We did the podcast with some of our summer interns and they also mentioned Richmond eateries.

Mentioning you coming here and taking on the role of research director, I imagine that many of our listeners might not be completely familiar with what a Reserve Bank research director does. How would you describe the role?

Kovner: I manage a group that includes PhD research economists, regional analysis, economic outreach, community development, publications, and economic education.

I would describe the role I'm in as research director as understanding the U.S. economy, but with special attention to insights that come from our district, which includes Maryland; Washington, D.C.; most of West Virginia; Virginia; and the Carolinas. The insights that we develop about the U.S. economy inform Richmond Fed President Tom Barkin in his role on the Federal Open Market Committee, or the FOMC, where he's currently a member voting on monetary policy. We also play an important role in disseminating information about the U.S. economy and the financial system.

Sablik: Picking up on that a little bit, the Richmond Fed is, of course, one of 12 regional Reserve Banks in the Federal Reserve System, each with their own research directors and research departments. And then the Board of Governors also has its own research team. What would you say are the benefits for monetary policymakers of having 13 independent teams of economists working for the Fed?

Kovner: I see three benefits to this system.

First is the ability to develop independent views for each of the Reserve Bank presidents. Each FOMC cycle, we work closely with President Barkin to analyze the U.S. economic data.

Second is each Reserve Bank has got the understanding of the unique economic perspectives of the district. We're bringing, in Richmond for example, insights on the impact of Hurricane Helene, on the longshoremen's strike, as well as other things that we're hearing in our outreach from our district, which is in many ways a microcosm of the U.S. economy.

And third [is] the collective power that these different research groups bring to thinking about these topics. The long-run value proposition we have at the regional Feds is our ability to bring this independent and credible voice to the policy process. We're doing that through producing research and analysis, but also engaging externally to improve our communities.

Each economist has a different focus and area of expertise. So, like any large enterprise, the collective in making monetary policy benefits from that wisdom.

Sablik: You've been on the job for about five months now. Have you formulated a vision for the Richmond Fed's research?

Kovner: Our research group is a leader in bringing cutting edge research insights to inform U.S. economic policy. Our PhD economists are actively engaged in the academic community and developing policy relevant ideas and proposing and learning from the state of the art in economics.

We have an innovative approach to learning from external academics that we do through bringing top researchers into the bank in a week we call CORE Week. In that week, we intensely focus on leveraging in-person connections with our department and external researchers to talk about their innovative ideas.

The Research department here also includes our outreach, regional analysis, and community development groups. Bringing the insights we get from those groups together with high-quality academic perspectives is what I view to be a unique strength of the group, as well as an opportunity for us to continue to contribute.

Sablik: Are there any research initiatives going on at Richmond right now that you're particularly excited to work on?

Kovner: I'm really interested in the insights we bring from the CFO Survey — we do this together with Duke University and the Atlanta Fed — as well as [the] Community Development Financial Institution or CDFI Survey, which we execute on behalf of the Federal Reserve System every two years. To me, each of these initiatives shows us how the Research group brings new insights about the U.S. economy and in thinking about how the financial system is serving Americans.

One of the things we do in our district, in particular, is offer insights on the economic outlook through qualitative conversations with businesses and Americans throughout the district. The CFO Survey is another angle on that work, where we regularly survey CFOs about their company's prospects. We can learn about the prospects for the U.S. economy by making use of [the] ways answers to this survey have changed over time. As rates have changed and inflation is waning, we can add insights into our economic forecasts [and] understand better how investment responds to monetary policy. So, the results from this survey contribute to models of monetary transmission and inform academics.

Turning to the CDFI Survey, that collects information from more than 400 CDFIs across the U.S. We ask these important players questions about demand for products and services, what challenges they have in meeting demand, and what practices and policies they're engaging in to meet these challenges.

When I worked at the New York Fed on our response to the financial market disruptions caused by the COVID pandemic, I learned more about CDFIs and the way in which they serve different types of Americans, including nonprofits. So, I'm interested in learning more about these institutions through our survey because it also speaks to other things we're thinking about — for example, the needs of smaller towns to have access to finance as well as the needs of communities which have been historically underserved by financial institutions.

Sablik: As you mentioned, your background before coming to the Fed was in finance, and a lot of your research has focused heavily on the topic of financial stability. Shifting gears to get your views on some economic topics, when it comes to financial stability, in 2023 the U.S. experienced a brief but pretty significant banking turmoil. That's something that you've definitely examined in your research. What would you say are the key lessons that you took away from that episode?

Kovner: I learned a lot from the banking turmoil. As bank supervisors [and] as folks responsible for financial stability, when things like that happened, we have to do a lot of self-reflection to think about what could we have been doing differently to understand that.

I think one of the main lessons I learned about supervision from the banking turmoil was about the importance of forward-looking bank supervision. The Federal Reserve's vice chair for supervision, Michael Barr, led a report that looked at supervision in the context of the failure of Silicon Valley Bank, or SVB. In that report, he notes the extent to which SVB's board and management failed to manage their risks. They noted supervisors did not act quickly enough to resolve issues identified by supervisors, particularly as SVB had grown in size and complexity. This highlights, to me, how it's important for supervisors to understand the features of specific banks, such as their customer bases.

There has been some emphasis on reading the risk of social media-driven bank runs as a takeaway from the bank turmoil in 2023. But my own research on this topic finds that you can see banks that had similar risks — for example, as measured by similar amounts of losses on long duration assets and high levels of uninsured deposits. Even banks with those similar risks were not run on. So, the extent to which SVB depositors were correlated with each other, then, was a very important risk factor in leading to the bank run. I think it highlights the importance of qualitative understanding that supervisors develop about the banks they supervise.

One perennial lesson, which is not necessarily unique to March of 2023, is that when we see a divergence between the market value of banks' assets and the book value of banks' assets, that's often something that leads to risk in the U.S. banking system.

Industry participants also raise concerns that too much or too engaged supervision will hamper bank lending. My research suggests that at current levels of bank supervision, empirically we're not yet approaching that trade off. We find that banks that receive more supervisory attention grow similarly to other banks in terms of asset growth and loan growth but have less risk, which is a difference particularly revealed in economic downturns. This suggests that some additional supervisory resources may actually benefit the banking system.

And I think there's an important financial stability lesson here. In general, economists focus on aggregates. Aggregate sets of things naturally lend themselves to graphs and usefully summarized patterns. But banks are not fungible. By this, I mean that when we add up capital and liquidity in all the banks in the United States, they don't necessarily aggregate. What really matters is what banks have losses, and if those same banks are the same banks that have a lot of capital and liquidity.

In 2023, we saw the weakness of ignoring the tails of the distribution of risks, particularly when there are very large banks taking on those risks. In this case, it was interest rate risk and rentable deposits. And so, it's really important for people who are monitoring financial stability to think about the aggregates but also if there are significant issues that are emerging in the tails.

Sablik: Very interesting.

In the wake of that banking turmoil last year, there's been quite a bit of discussion about the Fed's response, not just supervisory response but also in terms of emergency lending, including through avenues like the discount window.

The Fed is currently collecting feedback on the discount window and evaluating potential improvements there. Based on your research, where do you think the Fed should focus its attention?

Kovner: The challenge of the lender of last resort, almost since its inception, is getting banks to actually borrow. Though discount window borrowing rose since mid-2022 and accelerated into March of 2023, we continue to see evidence of what's called stigma, despite the penalty rate removal in 2020. Stigma means that banks seem to act as if there's some sort of stain on their reputation, and it stops them from making use of the discount window.

One piece of evidence we have for this is that we see borrowing in the fed funds market at an interest rate in excess of the primary credit rate, meaning I could borrow from the discount window at 5 percent and, instead, I borrow from another bank at 6 percent — that's maybe a little larger number than the actual spreads that we see. That is, of course, evidence that there's something about this type of lending that banks are reluctant to engage in. We saw that these fed funds transactions in excess of the primary credit rate started growing in October of 2022, months before the March 2023 banking turmoil, and has continued.

I point out that we have some types of lender of last resort facilities that have been very successful, as measured both by usage as well as in the way in which they have supported lending by banks. The Bank Term Funding program, or the BTFP, is an example of that. It's been extensively used and economists have found evidence that it supports lending by banks that have borrowed from the facility. I think that's consistent with banks having a preference for a temporary lender of last resort facility, particularly when it has favorable pricing and collateral policies. Nevertheless, I think making sure that we maintain operational readiness is critical to this capability, particularly at times when there are signals of vulnerability in the banking system.

Sablik: You sort of touched on this already in discussing some of the lessons from the crisis. What would you say are the major risks that are facing banks today, and how do you feel the banking system is positioned against those risks?

Kovner: I observe that the two largest risks I see for banks today are interest rates that may stay higher for longer and cyber risk.

First, a core mandate of risk management for banks has, and has always been, interest rate risk management. Banks need to be prepared for any number of different potential rate paths. Some features of the current strong U.S. economy, such as higher productivity, are also associated with higher long-run rates. This would be good, is good, for the U.S. economy. But banks with long duration assets or loan portfolios exposed to commercial real estate that have been hoping to make those project cash flows improve with lower rates would then be at risk.

Second, cyber risk — both to banks directly as well as to significant service providers of those banks — remains a sizable threat. The financial industry has long been a key target for cyber criminals — as they say, criminals seek out banks because that is where the money is. But increasingly, we've seen risk to banks also through their service providers and it can be very hard to track exposures to these risks.

Bank supervisors are focused on both of the risks I just mentioned and working hard to mitigate them.

Sablik: We did an episode on cyber risks in the financial system earlier in the year, so I definitely recommend listeners check that out.

Your mention of interest rate risks is a good segue to talk about monetary policy which, as you well know, is at a pivotal moment right now. In September, the Fed lowered its policy rate for the first time since the pandemic started in March 2020 and it cut rates again just about a week ago on November 7.

What is your view of the state of the economy right now, particularly when it comes to the balance of risks between the Fed's dual objectives of stable prices and maximum employment?

Kovner: I have to say, this is another question that makes me long to start with the disclaimer of these are going to be my own views.

The U.S. economy has been remarkably strong and resilient, led by a strong consumer. It's important to recall that a lot of the challenges that the economy has faced in the last five to 10 years have arisen from what economists call negative shocks. In particular, shocks to the supply of goods and services — first the pandemic disruptions to services through the need to reduce exposure to other people, then the related supply chain disruptions, then the geopolitical risks such as the Russian invasion of Ukraine — made it much harder to manage the economy towards our dual mandate goals of stable prices and maximum employment.

I'm optimistic that we're moving to a place where these negative supply shocks are subsiding and the economy is returning towards solid economic growth that can be sustainable without sparking the high inflation that's been so painful for Americans.

I think of the U.S. economy as similar to a boat approaching its dock at stable prices and maximum employment. Risks to pulling into the marina come from inflation stabilizing at higher than our target of 2 percent but also from the currents of demand flowing by too much and leading to higher layoffs.

For now, we're bringing our boat into dock as the headwinds of price increases have subsided due to customers resistance to further price increases. We're seeing measures of wage inflation, such as the ECI [Employment Cost Index], returning to levels that are consistent with stable prices. The tide of job vacancies has returned to levels closer to the supply of workers. So, I see that as a tide that's not pushing our boat further offshore. The risks of geopolitical conflicts remain high, although it's possible that slow growth in countries outside of the United States could further mitigate price increases or reduce inflation risks. By all measures, we have maintained consumers' long-run inflation expectations at low levels, and that's a necessary ingredient in keeping our boat afloat.

The FOMC's recent reductions in the target rate are an effort to start to slow the ship so that as we get closer to our endpoint, we can observe the data and chart our course accordingly.

Sablik: The boat metaphor is a great segue to talking about r-star. Fed Chair Powell has used the metaphor of navigating by the stars in the past. There's certainly a big debate among economists right now about the natural rate of interest, or r-star as it's called in economic models. It's something we've discussed on this show earlier this year.

R-star determines where interest rates will settle in the long run, but it isn't something that policymakers can directly observe. Some have argued that r-star has risen since the pandemic, while others maintain that it'll return to the low levels that we saw in the 2010s.

Keeping with asking you all the hard-hitting questions, what's your take on this?

Kovner: I hope as we try to bring our boat into the dock that we are navigating with sonar and radar in addition to the stars. Thinking about this long-run rate of interest at which the economy would be in balance as a really critical object.

I usually think of this — rather than "r-star" or the "natural rate" — as the "neutral" rate of interest, because it's the rate at which the economy is in neutral, at which monetary policy would neither be contractionary nor expansionary. It would be a rate at which the economy could be achieving its full employment and stable inflation. Maybe the first thing to note about this Goldilocks is it can't be observed directly, and it's not necessarily a constant number.

So, taking a step back, what is r-star? How would we know if we're getting there? Economists make use of different models to estimate this neutral rate. Thomas Lubik and his co-authors have such a model and we post its estimates at our website. The median estimate as of around the middle of this year was about 2.6 percent. Another well-known estimate comes from Fed economists, including the president of the New York Fed, and those models estimate the real rate to be well under 1 percent. So, not only do different models offer estimates that are materially different, each model typically has quite a large error band, meaning that the estimates of this rate are not very precise.

I don't have a favorite model for r-star, but I prefer to think about the information we get from a range of approaches, as well as from the real economy. But of course, interpreting signals from the real economy is hard because it's buffeted by shocks, including geopolitical conflict, changes in fiscal spending as well as changes in how businesses and consumers are exposed to rates. All of these are going to affect how much we think monetary policy is affecting the economy.

Seeking r-star or the neutral rate is a perennial challenge for economists. I look forward to the ongoing work of economists at the Richmond Fed in shedding new light on this question, or perhaps I should say, in building new telescopes to seek out the star.

Sablik: Well, Anna, thank you so much for joining me today and I hope we can talk again soon.

Kovner: Thank you and congratulations on your "sesquicentennial" podcast.