FED FOCUS-How a Fed inflation hawk changed his mind

By Ann Saphir

CHICAGO, Oct 9 (Reuters) - Narayana Kocherlakota surprisedeconomists around the world last month when he called on theU.S. central bank to hold interest rates near zero, possibly forseveral years to come.

One of the newest members of the Federal Reserve's top tablehad been seen by many in financial markets as one of its moreinflation-focused "hawks."

Only six months earlier, the head of the Minneapolis Fed hadbeen calling for a tightening of monetary policy by the end ofthis year.

So it was considered an unusually swift about-face whenKocherlakota proposed keeping the Fed's benchmark rate near zerountil unemployment is brought way below its current level.

For those who know him well, it was no surprise.

"Narayana was a very independent student. That was somethingI saw at a very young age," said Lars Peter Hansen, a professorat the University of Chicago, where Kocherlakota completed hisdissertation at age 23, having entered Princeton University justbefore his 16th birthday.

"I've never really seen him as a person who is rigid."

Kocherlakota was unusually eclectic in his research and hejumped from one discipline to another with ease, Hansen said.

Born in Baltimore, Kocherlakota spent most of his childhoodin Winnipeg, Canada, where his parents taught statistics at theUniversity of Manitoba. His father was an immigrant from Indiaand his mother hailed from a Pittsburgh suburb.

Kocherlakota now lives with his wife, also an economist, andtwo Australian shepherd dogs in the Minneapolis suburb of GoldenValley, where he watches "a totally embarrassing amount ofsports on TV," as he told an employee newsletter after takingthe top job at the Minneapolis Fed in 2009.

As Wall Street Fed-watchers reassessed him after hisheadline-grabbing speech last month, Kocherlakota said he hadbeen persuaded by fellow economists that lower interest ratescould indeed boost employment, despite his previous skepticism.

Work by Edward Lazear, a professor at Stanford GraduateSchool of Business, and a speech by Fed Chairman Ben Bernanke atthis year's Jackson Hole conference convinced him that the U.S.labor market had not undergone such major, structural changesthat monetary policy would not help reduce joblessness, he said.

He was also struck by how inflation had ticked down morethan he had expected.

Kocherlakota was keen to downplay talk of a suddenconversion to a new view on the economy. "I wouldn't say I wokeup one morning and thought it; it was more a cumulativeprocess," he told reporters.


Colleagues put it simply: he cares about on-the-ground data,and he knows how to listen.

That much was clear in August when Kocherlakota, who turns49 on Friday, donned a pair of jeans and took his board's ninedirectors on a tour of the booming oil fields of North Dakota.

In a 14-hour, 300-mile bus trek, they visited a frackingrig, a pipeline, a workers' camp, and a natural gas plant. Theyheard locals speak of life in the heart of the U.S. energy boom.

"His style is to let everybody else do the talking and helistens intently," said Lawrence Simkins, one of the boardmembers and president of Montana-based Washington Cos, aprivately owned transportation and equipment firm.

As the bus maneuvered truck-clogged roads, Kocherlakota gotinto a discussion with another director about the mental healthtoll on workers separated for months on end from their families.

Despite his reputation as an inflation hawk, Kocherlakota'spush for the Fed to do more to stimulate the economy was not abolt from the blue. He praised its first round of bond buying,which began in 2008, and backed its second round in 2010.

Those programs took place against the backdrop of a U.S.economy in crisis or still limping its way back to recovery.

Last year Kocherlakota opposed further Fed easing becausethe economy, in his view, was mending.

At the same time, he liked the thinking behind a proposalfrom Chicago Fed President Charles Evans, one of the Fed's mostdovishly growth-focused policymakers, to promise to keepinterest rates low until unemployment fell below 7 percent, aslong as inflation did not threaten to breach 3 percent.

Tying policy to economic milestones, Evans argued, boostsits effectiveness.

"I thought he framed things pretty nicely," Kocherlakotasaid last October. "But actually getting into the quantities,that's something I'd have to think about more, and also discusswith my colleagues more."

Less than two months later, he had his own outline: The Fedshould spell out how it would respond to a rise or decline inunemployment, and to changes in the inflation outlook.


Kocherlakota and Evans sit next to one another at the27-foot-long elliptical mahogany table around which Fedofficials gather every six weeks in Washington to decidemonetary policy.

They had made an unlikely couple, given their longcontrasting views on the role of interest rates in stirring jobsgrowth.

That changed at the Fed's meeting last month. As fellowpolicymakers agreed to a third and this time open-ended round ofbond-buying to spur the U.S economy, Kocherlakota said inflation

running below his forecast left room for the Fed to keep rateslow for years.

For a week, he kept his plan under wraps before announcingit to an audience of roughly 80 people at a community college inWestern Michigan, known locally for training ski-lift operators.

He said the Fed should not even start talking abouttightening monetary policy until the jobless rate dropped to 5.5percent - a big drop from just under 8 percent in September --or until the medium-term outlook for inflation topped 2.25percent.

The plan drew immediate criticism.

If the Fed adopted it, "inflation credibility would not beeroded. It would be exploded," said Eric Green of TD Securities,a former senior economist at the New York Fed. "His views werequite different six months ago and will no doubt be verydifferent again" when he rotates into a voting spot on the Fed'spolicy-setting panel in 2014.

But Kocherlakota's former professor Hansen said the plan isnot a radical shift, noting it allows very little deviance fromthe Fed's 2-percent inflation goal.

So far, Kocherlakota has won little public backing from Fedcolleagues.

Hawkish policymakers worry that more Fed easing will nothelp the economy and could fuel inflation expectations.

San Francisco Fed President John Williams, a centrist, saidthe plan risks overheating the economy.

By contrast, Chicago's dovish Evans fears it could cause theFed to tighten too soon because it only allows "a very modestincrease in inflation" over its 2-percent target.

Nonetheless, the relatively new idea of tying Fed policy tospecific economic turning points is gaining traction.

Fed policymakers left out any numerical thresholds forjoblessness and inflation when they began their new round ofasset purchases last month. But most still think doing so wouldbe useful in providing more clarity about their policyintentions, minutes of their most recent meeting show.

Those who know Kocherlakota caution against discounting hispersuasive powers, which helped him get his job in the firstplace, according to Mary Brainerd, chief executive ofhealth-insurance firm HealthPartners and Minneapolis Fed Boardchair.

"Because he communicates clearly and thoughtfully, he's verycompelling," she said.

(Additional reporting by Pedro da Costa in Washington; edtingby William Schomberg, Tim Ahmann and Gerald E. McCormick)


nnsaphir)(Reuters Messaging:ann.saphir.thomsonreuters.com@reuters.net))