Before I tell you what I think about Trump’s nominee for Fed Chairman, Kevin Warsh, I should first confess to the fact that my opinion of Chairman Powell has changed several times since he was first nominated. That’s a user-beware warning about my thoughts below, but it’s not just about me. I’ve watched the Fed since about 1990 – I wrote a book leaning against the perception of Chairman Greenspan as some kind of “Maestro” – but what happens when individuals meet institutions is that both are changed. The classic example is that Presidents always govern closer to the middle than their campaign rhetoric, but it is a general rule.
In Powell’s case, I was initially very optimistic. Powell was a non-economist, the first such to have led the Fed since G. William Millers’ brief tenure prior to Volcker. “Maybe,” I thought, “Powell will be less likely to automatically buy into the assumptions of the poorly-performing models the Fed has used for the last few decades, and move away from them. My opinion fairly quickly shifted once he became Chairman and made it abundantly clear that he had basically learned everything he needed to know about monetary policy from the existing staff at the Fed. Total regulatory capture, in other words. And he moved too slowly when COVID hit and it was very obvious that inflation was going to spike given the government’s efforts to keep demand strong with lots of money, while supply had collapsed. He was totally Team Transitory, and totally wrong.
But then, the Fed actually started raising rates, and raised them far more than I thought that a traditionally-dovish institution was going to. My opinion of Powell rose again. Yes, it was exactly inverted to the right approach – instead of raising rates and letting the balance sheet stay large, he should have kept rates low and slashed the balance sheet – but he at least thought he was being hawkish. My opinion of him took a final turn lower, when his Fed made nakedly-political interest rate moves in the runup to the 2024 election.
In the end, I rank Powell well above the disastrous Yellen and the disconnected-from-the-real-world Bernanke, but below Greenspan. Indeed, while I don’t think Greenspan was any part of a “Maestro,” and he changed the Fed in some incredibly damaging ways (making it far too transparent)…I feel kind of bad in retrospect for my book since his three successors have all been worse.
Anyway, that is a long prologue but let’s face it, we have far more information about Powell than we do about Warsh. I want it to be a warning, though, about the fact that whatever I/we think today about Warsh, we should let his future actions inform our opinions!
So here’s what I think…and I am only telling you because some of you asked:
I think Trump could have done a lot worse than Warsh. While the President regularly confounds his critics by making solid decisions when they expect the ravings of a madman, this one surprised me too. For all his railing about how interest rates should be lower, and the Fed was moving too slowly, etcetera, he ended up choosing someone who is certainly on the hawkish side of the ledger…certainly with respect to the other people supposedly being considered.
Now, Trump isn’t wrong when he says the Fed did not manage the inflation spike or its aftermath very well. As I’ve said for a long, long time, managing inflation is about managing the money supply – and interest rates have nothing to do with inflation. I don’t think Trump is being this nuanced, but it’s the right answer: shrink the balance sheet, rein in money growth in other ways…and lower interest rates, because one thing we do know is that money velocity is influenced by interest rates. That’s how you get a non-inflationary boom, and it would be funny if Trump got there by accident. (Or…is it?)
But this is the way Warsh is supposedly leaning: near-term dovish, but hawkish on the balance sheet. Also important, as I alluded to earlier when talking about how the Fed has become more and more transparent: allegedly Warsh tends towards less communication about policy. If you want to de-lever the dangerously levered global financial system, a great place to start would be to decrease the predictability of monetary policy. More visibility = more risk taken, which increases systemic risk.
One of the things I hope for Warsh is that he ignores Bill Dudley’s advice, given today in a Bloomberg column. Dudley’s #1 piece of advice was “first, he has to win the confidence of his colleagues at the Fed. Although the chair directs the Fed’s staff and sets the agenda at each meeting of the policymaking Federal Open Market Committee, ultimately he has just one of 12 votes. To truly wield power, he’ll have to earn respect. He’s made this more difficult with his persistent criticism that the central bank needs “regime change” and that he might need to “break some heads.””
The incoming Chairman should completely ignore that. It’s nonsense and Dudley knows that. The power to set the agenda is the only power that matters – no Fed Chair has ever been even remotely close to being outvoted, and that’s partly because no Chair would ever call a vote he could lose. Dudley, and all Fed careerists, want to make sure the vast staff at the Eccles Building matters, and that the bureaucracy continues to be what actually sets policy. This is exactly what the President is complaining about, and he is not wrong!
The Fed doesn’t need to be “ended,” but it needs to be a lot more opaque and a lot more introspective about the historical incidence of Fed actions that caused harm versus those that caused good. It needs to be tighter on the balance sheet; overnight interest rates are roughly neutral but don’t really matter that much. At first blush, from my perspective, Warsh falls on the right side of those divides. Casting back to my earlier warning that I am willing and able to have my mind changed on this score as we learn more about the Warsh Fed, I will say at this point that I am pleasantly surprised.
