No joke: Tightening reminds Kocherlakota of wearing shorts in Minnesota

Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis
Brian Snyder | Reuters
Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis

It sounds like the setup to a corny joke: Why is raising the federal funds rate target like wearing shorts in Minnesota?

But that is precisely the heuristic device used by the colorful and oft-dissenting Minneapolis Federal Reserve president, Narayana Kocherlakota.

In the question-and-answer session following a speech he gave in New York on Tuesday night, Kocherlakota was asked about the theory that one benefit of tightening Federal Reserve policy is that it gives the central bank room to loosen policy if economic conditions so warrant.

Kocherlakota, who dissented to the December Fed statement and doesn't favor a 2015 rate hike, responded that tightening policy should never become a goal in and of itself. And he used a personal story to illustrate that point.

"The first year I lived in Minnesota, when May came around, I figured, hey, it might be time to wear shorts. After all, I'd been wearing pants for a while at that point. So, I put on shorts. And well, let's just say that the next day, I was wearing pants again," he said, to some laughter from the audience.

So what lesson did he learn that chilly spring day?

"The goal is not to put on shorts just to put on shorts. The goal is to have a condition in which it's good to put on shorts—or to raise rates."

Read MoreMarkets push out rate hike expectations to October

And as the Minnesota Fed president made clear, he doesn't believe the economy is sufficiently sunny, as it were, to warrant a Fed rate hike. He believes that unemployment still has some room to fall. And more importantly, inflation is still well below the Fed's stated goal of 2 percent, such that a hike now could hurt the Fed's credibility regarding its inflation target.

That tells him that the Fed ended quantitative easing too early, and is jumping the gun by looking to raise rates this year.

"Monetary stimulus pushes both employment and prices in the same direction. By providing somewhat more stimulus, the FOMC could have stimulated at least somewhat more employment growth, without creating undue inflation," he said in his prepared remarks at the MNI-hosted event.

In the December Federal Open Markets Committee meeting statement to which Kocherlakota (who is not a voting member in 2015) dissented, the policymakers said it would be "patient in beginning to normalize the stance of monetary policy," which is a mild shift from the earlier "considerable time" language. The committee did take pains to note that this fresh guidance is "consistent" with the "considerable time" noted in its prior statement.

Many market participants believe the first rate hike will come in October, though some believe it will come as early as June. After all, the fed funds rate target has been between 0 and 0.25 percent since December 2008, and the economy has improved significantly over the past six years.

Yet for Kocherlakota, it's not about how long monetary policy has been easy—or about how long Minnesotans have been wearing long pants. The more salient factor is the weather outside.

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