WSJ What’s News - Goldman Vice Chairman and Former Fed Official Kaplan on Rate-Cut Dilemma

Episode Date: May 4, 2025

Will the Federal Reserve cut interest rates this year? How is Fed Chair Jerome Powell and central bankers thinking about recent volatility in financial markets? This week, we’re bringing you an episode of WSJ’s Take On the Week, where hosts Telis Demos and Gunjan Banerji talk to the people closest to the hot topics in markets to get incisive analysis on the big trades, key players in finance and business news. Gunjan and Telis talk to Rob Kaplan, vice chairman at Goldman Sachs and former president and CEO of the Federal Reserve Bank of Dallas, about the central bank’s tough task ahead to lower inflation. They also dive into President Trump’s recent remarks about Powell and the Fed independence debate. If you like this episode, check out more of WSJ’s Take On the Week. Learn more about your ad choices. Visit megaphone.fm/adchoices

Capital Group and KKR are bringing public and private credit together, seeking to unlock opportunities previously out of reach for you and your clients. Visit CapitalGroup.com slash plus to learn more. Capital Client Group, Inc. Hey, What's New listeners, it's Sunday, May 4th. I'm Luke Vargas for the Wall Street Journal. And this is What's New Sunday, where we take a step back to look at the stories moving the agenda.

So we thought you would enjoy this episode of our podcast WSJ's Take on the Week, which cuts through the noise by talking to the people closest to the hottest topics in markets and business news. This week, the Federal Reserve is set to meet on Tuesday with the central bank at a crossroads, facing widespread uncertainty in the economy and pressure from the Trump administration. So what can we expect from the upcoming interest rate decision and what could it mean for markets, businesses and consumers?

Hosts Gunjan Banerjee and Talas Demos speak with Rob Kaplan, Vice Chairman of Goldman Sachs and former President and CEO of the Federal Reserve Bank of Dallas. If you like what you hear, go and subscribe to WSJ's Take On The Week. We've left a link to help you do that in our show notes. Welcome to WSJ's Take On The Week. I'm Gunjan Banerjee. And I'm Telus Deimos. We are facing one of the most uncertain economic moments in recent history. And the Federal Reserve is at a crossroads. Will it cut interest rates this year? And how are

central bankers thinking about the intense volatility in financial markets? We have the perfect person to chat with us about this today. We have Rob Kaplan, who is vice chairman at Goldman Sachs. He previously served as president and CEO of the Federal Reserve Bank of Dallas. Rob, thank you for joining us. Good to be here. Thanks for having me. So we have a really big Fed meeting coming up. It feels like more than ever, the Fed and investors are just navigating a really, really

uncertain time. How are you thinking about this moment in light of tariffs, the economy, and everything else going on right now? So what you're seeing is a shift in that for the last couple of years, I think a lot of the focus was on the Fed and first they're tightening and then they're beginning to ease. We're now shifting more towards structural drivers in the US economy, which the Fed doesn't drive. The executive branch and Congress drive the structural drivers, and those include an effort to cut government spending, reduce deficits, regulatory review in every industry, an effort to restructure the energy

ecosystem to lower prices at the pump and for low-modern income families. We're seeing a dramatic change in immigration and immigration policy, which is reducing workforce growth. And then the last big one is obviously tariffs, which we could spend the whole time talking about. But those are five very significant changes. The Fed is most comfortable when there's a clear outlook and then they can adjust policy to those outlook. When you've got this many structural changes and some of them are still unclear, tariffs is a good example. I think the Fed has to wait until

some of these decisions clarify. And the other reason to wait is we still have an inflation issue. And so the Fed has to be patient for this to clarify because they're still trying to make sure people know they're fighting inflation. And on top of that, you might have an economy that's already slowing, as we saw in the data recently. So the economy is reacting to these structural changes. We started the year, I think most economists might have called for two and a quarter, two and a half percent GDP growth.

Those estimates have steadily declined. Probabilities of recession have increased. What we're actually seeing in the economy in terms of the real data is shipping is down, travel is down, tourism is down. Most companies I talked to in the first quarter, business has been not great, but it's been solid. And even today, they haven't seen a substantial fall off but they're expecting it and that's where we are right now. You've said you're worried about stagflation. Tell us why.

Stagflation means slower growth and stickier prices. So we obviously just got the actual GDP number for the first quarter although it will be subsequently revised but was negative. Not surprising. It was a little disappointing to some. And you see economists slowing down their growth estimates for the year. So why are they doing that? Government spending cuts, slow growth. Regulatory reform should help productivity, would help growth, but it takes time. Immigration reduction, workforce growth reduction, slow growth, and tariffs probably slow growth, but also create a cost push

that might actually cause prices to be stickier. And that's what the Fed's trying to figure out. And so yeah, that combination means slower growth and stickier prices, at least in this first phase. And that's why you hear people talking about stagflation. How does the Federal Reserve think about price growth when it's being driven by something that's so specific, policy driven, right? Because sometimes prices rise because the economy is overheating, right? That's the kind of early 1990s sort of type type price growth, right? This is something a little different. Does the Fed think differently

about it or is a rising price a rising price a rising price and the Fed always reacts similarly? It'll react differently. So going in, I'll call it pre-January 20th, goods ironically were disinflating globally. One of the reasons for that is dramatic overcapacity in China and global manufacturing overcapacity. The inflation issue was due to services, sticky rents and maybe sticky wages, and that was probably driven to some extent by excess government spending, excess demand, not supply. Now we're heading into this new set of policies and the Fed is adjusting. Tariffs are about goods. Well, we haven't had a goods problem. Well, we may now. And so they're trying to

figure out will increasing costs due to tariffs translate into higher prices? Now, the reason I say will they, it's not a certainty. You can negotiate with your suppliers. You can take some amount out of your margin if you're a company. You can increase prices. You may not increase prices all at once.

And you don't know what the level of the tariffs are going to be and it varies by country and it's still the jury's still out. And so what what they're struggling with is the inflation nexus has changed to a cost push issue on goods and it's unclear how much demand destruction, i.e., slowing growth, might offset that cost push. You just don't know yet. So it's interesting because I think a lot of investors think that if we tip into a recession this year, the Federal Reserve would cut.

One question I have is... And they might be right. Right. They might be right. In 2022, though, Powell did say, like, I thought that Powell made it clear that he was willing to accept a recession. Yes. And his priority was getting inflation back down to 2%.

And that's all true. And he was. And he warned that in order to get inflation down to 2, we may have to accept a recession. So why didn't we have a recession? I'll tell you why I think why we didn't. Fiscal spending has been historically high. American Rescue Act, Inflation Reduction Act, Infrastructure Act, CHIPS Act, we were running six and a half percent plus of GDP deficits, historically high. And so I think that helped cushion some of the Fed rate hikes. Now we're switching where we'll see how successful it is maybe unclear right now government spending they're going to try to reduce it as a percentage GDP unclear whether they're going to have success and it's clear the economy is now slowing. And so I think the Fed's going to be more balanced on the one hand looking at unemployment inflation. But it's this is why Jay Powell is in a speech a couple of weeks ago in Chicago, I believe, made clear we haven't given up on fighting inflation, because he's worried if he suggests that inflation expectations

might inch up more and become unanchored and doesn't want that to happen because if that happens it's going to be harder to cut rates not easier. Are investors wrong to think that the Fed will cut them in light of all of this? They're not wrong to think it. I think here's what we know here's what we don't know. I think the Fed is going to be in my opinion more reactive than preemptive. In 2019, I was at the Fed when we had a tariff issue. I advocated for preemption, but we could do that because we didn't have an inflation issue. The Fed here will be more reactive. If you see a severe slowing that I think on balance offsets some of this cost push. I think the Fed may well see its way clear

to reducing rates multiple times, but the Fed shouldn't be in the business of predicting that because it needs to see it before it acts because it's unclear. And so the market has to make predictions because we've got to invest. The Fed should be more of a risk manager. And I would advise investors, realize there's a whole bunch of scenarios because we don't

know what the tariffs are going to be. We don't know what ultimately how far we're going to go on deporting undocumented immigrants, reducing workforce growth even further. And you don't know how this government spending effort's going to work out. That's a lot of uncertainty. And so just be prepared. This may be, this is unpredictable. I think investors think that. Is there a level of unemployment at which the Fed would say, hey, we need to cut now? What is the tipping point? I think you will see if you saw the unemployment rate, remember the

Fed's mandate is full employment and price stability. It's not GDP, it's unemployment. If you saw unemployment begin to spike higher, where it's clear it's on its way to 5%, I think that would, if I were at the fed, that would get me on my front foot that maybe I might be willing to take some liberties in thinking that demand destruction will offset some of this cost push. The other thing that would cause the Fed to act if you saw disorder in either the Treasury market or the other financial markets. We haven't seen it yet. We got close. Well, we haven't seen it yet.

I think it's not a great combination. We talked right before this interview. When gold is going up, the dollar is weakening, the 10-year is inching back up while the market is selling off. That is not what you want while the market is selling off. That is not what you want to see. Scary, yeah. But it happened in an orderly way. I think the Fed is on their toes looking at overnight

liquidity and market function. If that continues to be orderly, they won't act, but they're watching it. So the market is expecting around three great cuts this year. How many do you think we'll get? I'll put it this way. There'll be a new SEP, Summary of Economic Projections, in June. If I were submitting my estimate in March, I would have said two. If I were submitting in June, believe it or not, I might also say two. That's less than the market expects, but I want to do that deliberately in that I want to leave our options open depending on what happens with these tariff and other decisions. And I don't want to be in a position where we sort of indicated to the market we're going to do more than we're really able to do.

And so I think the market is likely to be disappointed with the Fed forecast in June for how much they're going to do. That doesn't mean they won't do more. It means they want to retain their operating flexibility. And again, I've said this, you want to be in this period a risk manager, not necessarily a prognosticator. We've talked a lot over the last several years about economic data and the economic sentiment, the vibes. You've been in the room for these Fed conversations. How seriously do they take those sentiment indicators? So you look at all of it.

You look at the soft data, you look at the hard data, and I know from experience sometimes weakness in the soft data doesn't always translate into what happens with the hard data. And also you've got governments in the midst of making decisions that can change sentiment. The one piece of soft data that I would rank above many of the others is inflation expectations. The Fed is very focused not only on bringing inflation down to two, but making sure that inflation expectations remain anchored so that people still believe the 2% goal is credible. Why? Why is that so important?

What does that change about people's behavior if those expectations are high? History has shown that if inflation expectations start to inch up, then maybe businesses start to preemptively raise price. Consumers start to buy thinking prices are going up. We just saw that recently. But we're consumers increase their purchases, we think, because they thought prices are going up. That means inflationary expectations are moving up.

You do not want that at the Fed. You want them to be anchored because if they become unanchored and behavior changes as a result of it, it's harder to get to the 2% target. So they're gonna be watching that very carefully. So if you see Jay Powell or other Fed speakers sound more hawkish, I would

be too. Even if I were thinking I want to look for a way to cut, I would talk hawkish because I want to keep these inflation expectations anchored. Well right now they're very high. They're moving up and they're moving in the wrong direction and it does reflect behavior on the ground. Businesses are preempting, they're having the, there's a new word in the dictionary, it's called surcharge. I always heard the word, but it's on bills now, there's a surcharge and it's for either current or anticipated tariffs and consumers are starting to

get in their mind that if prices are moving up, you want to anchor that and the best way right now the Fed can do that is jawboning. So people shouldn't misinterpret it. Gee, J-PAL sounded very hawkish. That means they're not gonna do X, Y, Z. No, to me, it means he wants to keep their options open and he wants to anchor inflation. Well, so you're, you talk to CEOs,

you talk to business leaders. I talk to investors around the world too. And talk to investors. What is coming up in those conversations? Is tariffs and inflation sort of topic number one? Are there other things on people's minds? So for businesses, by and large, they'll adjust, but what's hard for them is something that happens abruptly. So, if there's a well-telegraphed change, they have time to adjust to it.

The auto companies are a good example. In a couple of years, over a year or two, they can make adjustments, they can make investments, they can change locations, but if it happens abruptly which this has a lot of businesses I talked to have a number of things they're working on to adjust but what they're saying to me is I just can't do it overnight might take me six months 12 months I can inch away different things in the meantime they have to make plans on how much they're gonna take out a margin how much they're gonna put in prices how much is gonna come out a dollar strengthening all that we're going the other way right now. That's what businesses are

doing. And they'll adjust to it, but they're working on it. On investors, investors are not just looking at tariffs, they're looking at the whole mosaic. And what I hear more and more from investors now is there's a lot more uncertainty. USMCA was an agreed trade agreement. They see some of the other things going on with higher education, other things that are a little jarring and surprising coming out of the United States. And what they're starting to think is maybe we ought to,

we started the year being over allocated the dollar in US assets. Maybe we should be rebalancing and reducing our dollar, not eliminating, but reducing our dollar exposure because there's enough unpredictability. And they're asking more questions. Is the institutional framework, is the predictability, which is one of the reasons I wanted to invest in the US, is that deteriorating and that's causing people to change asset allocation.

So we know that the message on tariffs changes day to day. Is there a point at which you think decision makers are going to say, you know what, this, I will make a decision to reshore, to build, you know, my next plant in the United States, to move production from one, I mean, Apple has talked about, you know, moving, moving things to India, right? That's to build my next plant in the United States, to move production from one... Already happening. Apple has talked about moving things to India, right? That's already in train. So it seems like people aren't necessarily waiting for full certainty.

They can't. Because A, it may never arrive. I mean, you'd have to wait to at least the midterms. Heck, you'd have to see who's the next president, right? Our business is acting today, would you say? Yes. They are already either making plans or starting to act on plans. Here's the issue. I'll give you a good example. Many folks,

companies I talked to had moved some manufacturing from China to Vietnam. Now we've got a very high tariff on Vietnam. So if we move to Vietnam, do we stay there and hope there'll be a trade agreement or do we move? And they're trying to make risk management decisions. The one decision that many are struggling with is how much can they move to the United States. We know that's the one place where we won't have a tariff. However, costs are higher. And is this going to be a globally competitive investment and if the only reason it's competitive is a tariff moat, what if that tariff moat goes away in four or five years? So that's one of the issues

folks are wrestling with and also they're talking a lot about can we use technology to lower the costs and so you'll see a lot of this manufacturing that does get moved here, I would guess, is going to be heavy use of technology, 3D printing, other methods to lower the cost. So the biggest decision would be to start manufacturing again here in the United States. And that's the one that's the toughest to ultimately make. All right. And so let me just that's the toughest to ultimately make. So let me just put all this in context,

because it's easy to lose sight of this. The US economy is predominantly a services economy. We manufacture in the United States, I'll pick another 13 or 14% of GDP. We import, let's say, 10, 11, 12% goods. And global manufacturing as a percentage GDP globally is declining. Okay so this we shouldn't forget as we go through this we run a services surplus with the world. We're primarily a services economy. You

want to make sure that we don't do damage to services while we're trying to bolster goods. And so that's, again, the balance we have to weave. It's interesting because in the market, it feels like at times people are buying stocks again, people are buying treasuries again, the dollar is going up, gold is falling. This week, this week there. Well, I think over the past week we've seen moments where that kind of buy America trade comes back.

So it feels like people are still grappling with how different are things really gonna be? So here's here's why these new trade deals as they're announced are gonna be very informative There are some number of capital committers in the market and I talked to number who believe this has all been a negotiating strategy and that tariffs are gonna come down to closer to zero I'm afraid that there's another scenario, which is the Trump administration wants the tariff revenue based on their comments. It's unclear how much money Doge is saving. Hopefully they'll do it. They'll say, but it's unclear.

They want more tariff revenue and their objective may not be to negotiate down to zero, it might be negotiate down to 10 or 20 or 30. And that is going to make, create significant challenges. And we don't know exactly which way we're going, but you hear officials saying, we want the tariff revenue and how useful the tariff revenue is, particularly when they're talking about the tax bill and a desire to do more than extend the Trump tax cuts, to get tax on tips, tax on overtime, deductibility for buying a car. And so I think there's some confusion in the market and it's affecting securities buying, the dollar, gold, treasuries, all these asset classes. All right. Well, we're going to get more into this buy or sell America trade after a quick

break. When we come back, we'll have more with Rob Kaplan. And if you're enjoying the show, check us out on video. We're on YouTube. We'll leave a link in the show notes. You can find us on WSJ's podcast page. Americans love using their credit cards, the most secure and hassle-free way to pay. But DC politicians want to change that with the Durbin Marshall credit card bill. This bill lets corporate megastores pick how your credit card is processed,

allowing them to use untested payment networks that jeopardize your data security and rewards. Corporate megastores will make more money, and you pay the price. Tell Congress to Guard Your Card, because Americans lose when politicians choose. Learn more at GuardYourCard.com. One thing that almost every investor I'm chatting with is watching is, you know, this buy America trade right now. It feels like we started the year with everyone banking on another year of American exceptionalism.

U.S. stocks have outperformed almost every single year since the global financial crisis. What do you think of that trade right now? I think the U.S. exceptionalism thesis is not dead, it's alive and well, but I think it's very critical that we come out of this period over the next few years having retained US exceptionalism, the greatest companies in the world, the most innovative. I think our higher education system

is one of the gems of the United States and independent Fed rule of law predictability. I think when I hope when some of these structural changes we've worked through we want to get back where the world has confidence in the United States and we we keep building many of our great strengths which have put us in a position to outperform the world. Some people say that, okay, even if we were to rewind the clock and say, just kidding, no more tariffs, that confidence in America as a trading partner has been dinged.

Do you think that's the case? I think there will be some repair to do, but I actually believe we can do the damage control, but I think it will be broader than tariffs. It has to do with some of the decisions we're making on foreign policy, what we're doing with our own institutions. A number of these decisions, including tariffs, I think are central to that. And yes, we can come out of this with U.S. preeminence and having strength in our country, but it will require a real focus on that as an objective and some prioritization of many of these structural changes. Robbie, you mentioned in what goes into American exceptionalism, you mentioned Fed independence.

So let's talk about that for a second. A few weeks back, the journal reported that the White House lawyers were exploring whether or not President Trump could effectively fire Jerome Powell before the end of his term as Fed chair in 2026. President Trump has said that since that he has no intention of firing Jerome Powell, but he's also not shy about how he thinks the Fed is doing basically a terrible job in his eyes by not slashing rates. Why is Fed independence so important? Why did that episode really focus everyone's attention on this? Okay. So I talked about confidence in the institutional framework of the United States, rule of law, other significant aspects that people have come to rely on. One of those

institutional staples has been an independent, politically independent Federal Reserve, independent central bank, which means that the Fed, at least as it relates to monetary policy and setting the Fed funds rate, does it independent of political pressures and political considerations. So why is that so important? Because there are times, the last few years is a great example, where it's very unpopular for the Fed to do what it needs to do. It needed to raise rates dramatically in order to bring inflation down. It's very unpopular. You want to take that out of the political sphere and put it in

an independent organization that can make these tough decisions. Okay. So now we move to today. We've got these structural changes growth is slowing I Think the president Ununderstandably and others are hoping the Fed will be able to see their way clear to lower rates However, there's an inflation issue and I think J pal as I said is trying to jawbone at a minimum that issue and He wants to make sure that they balance their dual mandate

of full employment and price stability. And so an independent Fed gives a lot of confidence to the financial markets, in my opinion. It makes them more willing to buy the dollar, buy duration, buy US assets. But the other thing I would say is J-PAL doesn't set the Fed funds rate. There's a vote.

Now, the voters are all the governors. And a portion of the presidents, those votes rotate. I ran the Dallas Fed. I voted on a rotating basis. Even if J-PAL were gone, I can tell you I don't think there's a consensus around the table to cut rates in the May meeting. They're open to it, but that's even if J-PAL wasn't there. And so I think there's some realization that

institutionally, you've got to build a consensus. It's got to be based on facts, analysis, and debate. And I think they may have concluded that removing J-PAL, one, would be legally problematic, but also would be institutionally very unsettling to the world. And it might not cause any change. J-PAL will leave next year, first half of next year. They will pick someone new. You want that new person to be seen as also independent, I think, and preserving the independence of it and not make any pre-commitments to the administration about what he or she

will or won't do and I think they're gonna have to be careful about that. We're going to take a quick break and then we have one final question for Rob. To support sustainable food production, BHP is building one of the world's largest pot ash mines in Canada. Essential resources responsibly produced. It's happening now at BHP, a future resources company. So Rob, President Trump has been pretty vocal that he thinks Fed Chair Jerome Powell is not doing a great job, that he is too late to trim interest rates.

Granted, he does not often say this in a very respectful way. But in 30 seconds or less, is there any merit in the economic point that the president is making about rates? On the being late point, I've been critical of the Fed in 2021 and 22 that I thought the Fed should start tapering bond buying sooner than they did and start looking at raising rates sooner. So in that regard, you could criticize them and they might criticize themselves they were somewhat late.

The best analogy that I can think of is you're driving on the highway and you're going 65 or 70 miles an hour and people are in the backseat and they want you to go faster. At the same time, let's take that same highway but there's a rainstorm, there's a hail storm, there's terrible visibility. I don't think anybody's gonna be beating on you to go 65, 70 miles an hour. They're gonna say, you know, I'm going to go 35. And I don't think anybody's going to say, you're late, you're slow, we're going to get there 10 minutes later. You'd say, let's get there in one piece. And so he's right that the Fed is going to be more reactive. However, there's a lot of fog and rain and maybe some hail that makes their being slower, I think, justifiable, particularly

given inflation is still sticky in the United States. Well, Rob Kaplan, thank you so much for this wide ranging and very interesting conversation about the Federal Reserve, the economy and all else. Good to talk to you about. It's been great. Thank you. Thank you. And that's everything you need to know to take on your week.

The show is produced by Trina Menino, Jessica Fenton, and Michael Lavelle with help from Jess Jupiter. Michael Lavelle and Jessica Fenton are our sound designers and Michael also wrote our theme music. Aisha Al-Muslim is our development producer, Scott Salloway and Chris Zinsley are the deputy editors, and Philana Patterson is the head of news audio for The Wall Street Journal. For even more, head to wsj.com. I'm Telus Demos. And I'm Gunjan Banerjee. Until next time.

Vents speak. You should get foreign language credit in college for taking macroeconomics.