http://www.startribune.com/business/232695051.html

A shakeup at the Minneapolis Fed has included the departure of two high-profile research economists who were shown the door and the replacement of the bank’s research director.

The changes at the generally staid institution have raised eyebrows in the small, interconnected world of academic economics, with some raising questions about President Narayana Kocherlakota’s commitment to retaining top-flight economists.

“It sends a bad message,” said Ed Prescott, a Nobel Prize-winning economist who teaches at Arizona State University and spends part of each year at the Minneapolis Fed. “Something very good is breaking down rapidly. Will something new rise out of the ashes? I think that’s what Narayana hopes, but I’m not optimistic.”

A spokesman for the Federal Reserve Bank of Minneapolis said the bank will make no comment.

The biggest news is the exits of Patrick Kehoe and Ellen McGrattan, both prolific, highly-regarded economists with long tenures at the bank, one of 12 regional Fed branches.

Kehoe, a Harvard Ph.D who has taught at the University of Pennsylvania and University of Chicago, joined the Fed as a monetary adviser in 1997 and has been one of the bank’s top economists since.

“He’s a high profile person in the profession, a world class economist,” said Stephen Williamson, a former Minneapolis Fed economist who now works at the St. Louis Fed and teaches economics at Washington University in St. Louis.“He’s a big deal.”

Kehoe declined to comment, citing legal reasons. McGrattan said Kehoe was fired on Oct. 18. He already has a position at the U, which often shares economists with the Minneapolis Fed, and will stay on there. “Patrick Kehoe did not choose to quit or leave the Fed,” McGrattan said.

McGrattan, a Stanford Ph.D who taught at Duke University before joining the Minneapolis Fed in 1992, will take a position with the University of Minnesota in January and will go on upaid leave at the bank. She has been an adjunct professor at the U since 1993. She said she was shown the door at the Fed more implicitly than Kehoe.

“I had an outside offer from the university, and I was not retained by the Fed,” McGrattan said. “They did not make a counteroffer. Our lingo is to say that you’re being fired, but you’re not really being fired, you’re just not being retained.”

Prescott, who collaborates with McGrattan, said she is “developing into a star” and is a “great loss” for the bank.

Meanwhile, the bank’s research director, senior vice president Kei-Mu Yi, who was brought on by Kocherlakota in 2010, was replaced in October and given a new title -- special policy adviser to the president.

The Minneapolis Fed has a reputation as one of the premier economic research institutions in the country. A close partnership between the U and the bank created an innovative marriage of academic economic research and policy-making, a fruitful collaboration where economists such as Prescott, Tom Sargent, Chris Sims and Neil Wallace helped put the Minneapolis Fed and University of Minnesota on the map in the 1970s and 1980s.

Sargent, Sims and Prescott eventually won Nobel prizes in economics, and Sargent and Prescott still have ties to the U and the Minneapolis Fed. Kehoe and McGrattan were firmly in this tradition, which is why their exits are so perplexing in the academic community.

“That’s a very important change in direction,” Williamson said. “If it’s true that the decision comes from the president, it would be nice to know what that direction is and what the rationale is for it.”

Kocherlakota took over as president of the Federal Reserve Bank of Minneapolis in 2009, after spending several years in the same milieu as Kehoe and McGrattan. He was a research economist at the Minneapolis Fed in the late 1990s, consultant to the Minneapolis Fed from 1999 to 2009, taught at the U from 2005 to 2010 and was chair of the U’s department of economics when he was named president of the bank.

McGrattan said she does not know why Kocherlakota would let her or Kehoe leave the Minneapolis Fed -- “It’s absolutely mysterious to us,” she said -- but she said the circle of advisers to the president has shrunk since he arrived and she has been frozen out.

“The last time I talked to Narayana one on one was before he was the president,” she said.

There are subtle policy differences between Kocherlakota and the economists who are leaving. Kocherlakota has been at the center of a big debate over the effectiveness of the Federal Reserve’s low interest rate policy. He has pushed hard for nearly two years for the Federal Reserve to hold down interest rates until U.S. unemployment drops to 5.5 percent.

He argues, in general, that what are known as “New Keynesian” economic models are helpful. This school of thought leads to an expansive view of the power of monetary policy, and has helped create an unprecedented intervention in the financial markets by the country’s central bank -- the $85 billion a month bond-buying program known as quantitative easing.

But Kehoe and McGrattan published a paper in 2008 arguing that monetary policy can do little to affect the unemployment rate, and Fed policymakers should instead focus primarily on controlling inflation.

“New Keynesian models are not yet useful for policy analysis,” they wrote in the paper.

Prescott laments that this sort of debate within the bank, long encouraged, doesn’t appear to be welcome. “A good administator sets up a loyal opposition,” he said.

Policy differences aside, McGrattan questions the Minneapolis Fed’s commitment to retaining talented research economists. She said she pushed in the past two years for the bank to keep talented, up-and-coming economists Virgiliu Midrigan, Paco Buera and Kjetil Storesletten, all of whom have left.

“We can’t let guys walk out the door, otherwise it’s not going to be a top place,” she said. “It will be difficult for hiring in the future.”