I first became aware of Kevin Warsh, President Trump’s nominee to succeed Federal Reserve Chairman Jerome Powell, in 2006, when I was in graduate school and he was nominated to the Fed Board of Governors. Just 35, with a respectable (if unremarkable) career in finance but extremely well-connected politically, he raised more than a few skeptical eyebrows that he could survive the grueling Senate confirmation process (even Nobel laureates aren’t a lock). But 20 years later, Warsh may be just what the Fed needs to restore integrity to the institution.
In some ways, Warsh is an obvious pick: he looks the part, was a former Fed governor, and is close to the Trump administration. Yet he’s also a surprising choice: he is not a great scholar of monetary policy, did nothing notable in his finance career, and has a long history of taking more hawkish stances on monetary policy than Donald Trump.
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True, Powell was not a scholar of monetary policy, either—but he is a lawyer. In nominating him in 2017, the first Trump administration’s thinking was that, after three consecutive economics Ph.D.’s, the next Fed chair should be someone steeped in markets, with strong communication and political skills, backstopped by board members with strong academic training.
Powell wound up making several major errors, though keeping interest rates too high for too long was not one of them. Some of his missteps—letting the Fed wade into climate change and racial-justice issues, for example—made it more vulnerable to political attacks. His big policy errors include shifting the central bank’s focus to weight employment more than inflation during the 2019 framework review. This contributed to letting inflation get out of control, and it remains high today.
Though unemployment is a serious problem, putting greater emphasis on the issue was never wise. Monetary policy’s impact on unemployment is still not well understood, and some unemployment is caused by supply conditions, over which the Fed has less control. A greater focus on unemployment also makes the institution more subject to political capture, because favored groups can be singled out to justify loose monetary policy. Warsh’s history suggests that he would be more concerned with reducing inflation. Some central banks target only inflation.
Powell’s other significant error was expanding the Quantitative Easing (QE) program by more than doubling the Fed’s balance sheet during the pandemic—a decision that continues to distort the housing market. Today, the balance sheet is still large relative to earlier rounds of QE. Warsh probably would have made a different choice.
Warsh was serving on the Fed Board when QE began in November 2008, as well as during the change to the ample, or even abundant, reserve system during the financial crisis. At the time, interest rates stood at zero, and the Fed was looking to support the economy, so it paid interest on the money that banks kept parked at the Fed and bought long-dated treasuries and mortgage-backed securities, hoping to boost demand. These actions did change the scope of monetary policy: the Fed’s balance sheet is now much larger. But they also created many problems in exchange for few benefits, since we lack strong, consistent evidence that QE ever did, in fact, boost economic demand.
QE imposes many costs. One heavy one is that central banks face more outside interference, which undermines independence. That the Fed buys things other than short-term debt means that it will come under greater pressure to buy long-dated treasuries to reduce debt-service costs, and to buy more mortgage-backed securities to bring mortgage rates down.
The balance sheet’s sheer size also makes it a target. The Cares Act directed the Fed to extend credit to middle-market firms. The FDIC borrowed from the Fed, rather than the Treasury (which is bound by the debt limit) to bail out bank deposit holders.
Warsh’s desire to phase out QE, or even potentially pay a lower rate on reserves, could enhance financial stability and insulate the Fed from more political attacks.
More recently, Warsh sided with President Trump on cutting rates. This position seems at odds with what he has argued for on the board and as a fellow at the Hoover Institution. But if, as chair, Warsh acts in harmony with his statements over the last 15 years, he could be the one to restore more independence to the Fed and protect it from future interference.
Photo by Kyle Mazza/Anadolu via Getty Images