First of two articles
A fixture in business and economics in the Upper Midwest for decades, Arthur J. Rolnick credits his colleagues at the Federal Reserve Bank of Minneapolis for raising concerns about the “Too Big to Fail” philosophy as far back as the late 1970s.
MinnPost caught up with him on vacation to ask him about the Minneapolis Fed’s impact on economics and public policy and his plans for the future.
Rolnick, who will retire in July after 40 years at the Minneapolis Fed (25 of them as director of research), reflects on changes he’s seen in the Fed’s Ninth District during that time.
His replacement is Dr. Kei-Mu Yi, currently vice president and head of Monetary and Macroeconomic Research at the Federal Reserve Bank of Philadelphia, who will become senior vice president and director of research. Rolnick, a Detroit native and University of Minnesota graduate, plans to return to the U as co-director of the Human Capital Research Collaborative at the Humphrey Institute.
The Minneapolis Fed Ninth District is one of 12 Federal Reserve Bank districts in the country. It stretches 1,800 miles from east to west and encompasses 409,291 square miles, 12 percent of the county’s landmass, across six states: Minnesota, Montana, North and South Dakota, 26 counties in northwestern Wisconsin and the Upper Peninsula of Michigan. It is home to about 8.8 million people, or 3 percent of the U.S. population.
Here is the first part of MinnPost’s edited conversation with Rolnick:
MinnPost: How has the Ninth District changed in the 40 years you have been at the Fed?
Aft Rolnick: Like the country, the region has aged. We see more minorities and immigrants coming into the region. That obviously changes the culture and makeup of the workforce. The region has also become much less parochial, much more international than it was 35 or 40 years ago — especially Minnesota. Even small businesses are doing a lot of commerce overseas, in China, Russia, India. We’re not unique in that way. The way technology has connected people around the world, the economy has become one market and the region reflects that.
MP: Has Fed research changed over that time?
AR: There’s no question the way we document the economy in the ninth district has changed due to the technological opening of borders. Research has much more recognition of international aspects of monetary policy than 40 years ago. As we speak with businesses, many with international contacts, we look at how closely related they are to the business cycle. Typically, we find the agricultural sector has its own drumbeat and the rest of the economy reflects the international business cycle.
MP: Has manufacturing become less dominant in the economy?
AR: You’ve got to be careful. I wouldn’t say it’s much less dominant in terms of output. In terms of the number of employees, it’s down, there is no question. But in terms of the percentage of the economy, it’s down just a little. Maybe it was 20 percent of GDP; now it’s 16 or 17 percent. There are fewer workers, down — I’m guessing here — 30 to 50 percent.
But we’ve become much more productive. Manufacturing over the years has done remarkably well. We’ve outsourced the less efficient manufacturing, we do manufacturing that’s more human capital and system based. That seems to be our niche here in the U.S.
MP: What is unique about the regional economy?
AR: Minnesota has one of the most educated workforces in the country. We started developing that sometime in the ’50s. We started pouring money into education and education reform, and it’s paid off for Minnesota’s economy and for the region as a whole. It’s the reason Minnesota has been able to attract and maintain so many Fortune 500 companies. I think on a per-capita basis, we’re No. 1. And that’s because of the quality of the workforce.
Education, human capital is going to be critical for sustainable economic growth. I don’t care what country you’re in — the United States, Russia, India, China or Poland. Companies want qualified workers and they’re willing to pay. That’s how you generate high quality jobs.
MP: What impact has the Minneapolis Fed had on economic research?
AR: I would give the Minneapolis Fed a lot of credit going back to the late ’70s when we first started publishing theoretical papers about one major issue, called the “Too Big to Fail” problem. When FDR signed the FDIC (Federal Deposit Insurance Corp.] Act in 1933, he warned that government guarantees could lead to very high-risk banking. It didn’t happen because banks were heavily regulated. Then we started to deregulate the banking industry. We [at the Minneapolis Fed] had been warning, ‘Be careful! Those government guarantees could lead to very risky behavior.’ The Fed Board looked at us and said, ‘We have this under control. Don’t worry about it, guys.’ We now blame the Savings & Loan debacle on that problem … and taxpayers paid the price in the ’80s.
We continued to write about this issue. The former president of the bank, Gary Stern and Ron Feldman, came out with a book, “Too Big to Fail,” in 2004 that warned of a potential problem.
MP: Why didn’t anyone pay attention?
AR: These ideas have been around for years. People in power knew about them … Whether you’re talking about secretaries of treasury or heads of FDIC or even people on the Federal Reserve Board, they thought this theory was not practical, that bankers didn’t behave that way, and the theory couldn’t explain the real world. They dismissed the S&L crisis as a onetime event and they just didn’t give enough weight to the possibility that, in the extreme, we could be right. Unfortunately, we needed a debacle like this for people to realize, “Yeah, this theory turns out to be correct.”
Now it’s getting a lot of attention. Washington is starting to realize “Too Big to Fail” is not just a theoretical problem. It is a real practical issue, and if we don’t do a good job of reforming the banking industry to price risk properly, we could well run into another financial debacle. The president and secretary of the Treasury are worried about this issue, and it looks like they’re going in the right direction.
I’m happy to say, from our point of view, we’ve been writing about this for over 30 years. I think it’s one of the best contributions this bank has made in the overall macro picture, in banking in particular.
Let me mention one other area … an intellectual revolution in macro economics that began at the University of Chicago and the Minneapolis Fed … around rational expectations. It questioned conventional economics and took into account what people expect in the future and how that affects behavior today. It changed the whole academic environment and eventually began to change public policy. That’s been another trademark of the Minneapolis Fed that’s influenced monetary policy.
It suggests, for example, that if you’re going to control inflation, you’ve got to communicate to Wall Street and the national markets that you’re committed to low inflation and put rules in place to keep long-term rates low. Most central banks today adhere to that policy.
One of our colleagues from the University of Chicago, Bob Lucas, got the Nobel Prize (for his influential work in rational expectations theory). Tom Sargent and Neil Wallace (both U of M professors and Minneapolis Fed research fellows) were working with him and will very likely get a Nobel Prize for their work eventually, plus it influenced Ed Prescott (also U of M professor and Minneapolis Fed research fellow) who did get the Nobel Prize in ’04.
Tuesday: How the public’s understanding of economics has changed