WSJ What’s News
Goldman Vice Chairman and Former Fed Official Kaplan on Rate-Cut Dilemma
Sun, 04 May 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
Chapter 1: What challenges is the Federal Reserve facing?
Welcome to WSJ's Take on the Week. I'm Gunjan Banerjee.
And I'm Telus Demos.
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.
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Chapter 2: What factors influence the Fed's interest rate decisions?
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 U.S. 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-moderate-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.
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Chapter 3: What is stagflation and why is it a concern?
Now we're heading into this new set of policies and the Fed is adjusting its 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 the jury's still out.
And so 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.
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Chapter 4: How do tariffs affect inflation and the economy?
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 two, 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 and inflation, but this is why Jay Powell 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.
think here's what we know and 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.
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Chapter 5: When might the Fed consider cutting interest rates?
It's 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 rate 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 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.
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Chapter 6: How do sentiment indicators impact Fed decisions?
OK, so 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, yeah.
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 going to be.
So here's why these new trade deals, as they're announced, are going to be very informative. There are some number of capital committers in the market. And I talked to a number of them who believe this has all been a negotiating strategy and that tariffs are going to 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.
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Chapter 7: Why is anchoring inflation expectations critical for the Fed?
And that is going to make the 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. Marc Thiessen 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 or on YouTube. We'll leave a link in the show notes. You can find us on WSJ's podcast page.
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One thing that almost every investor I'm chatting with is watching is 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?
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Chapter 8: What trends are seen in consumer behavior related to pricing?
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 U.S. 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, an independent fed world. rule of law, predictability.
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 keep building many of our great strengths, which have put us in a position to outperform the world.
Some people say that, OK, 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. 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.
Rob, 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 things. 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 to
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