What would Kevin Warsh’s Federal Reserve look like? | The Economist

Let's turn to to the Fed where the big news is  obviously that Kevin Warsh uh has been nominated. by President Trump as uh the new chairman of the  Fed. Um now he is someone who has good hair and. good looks and is as President Trump called  him from central casting. He was governor of. the Federal Reserve throughout the financial  crisis. extremely wellrespected uh Wall Street. man but he's Henry beyond that give us a kind  of quick summary of Wenomics what is it what is.

it about well uh what Kevin Warsh wants to do is  get interest rates down he's more or less said to. Trump to get the job that he he will do this  and the justifications he's come up with for. that are that one the AI boom is going to lead to  productivity surge and that will allow the Fed to. keep interest rates down because productivity  is disinflationary. It's good to have lots of. stuff. And the second part of that is that he  thinks you can shrink the Fed's balance sheet, which is another part of monetary policy, and  that's contractionary. And to offset that,

you can cut interest rates, a bit like pressing  the brake and the accelerator on the car at the. same time. So those are the two planks of  Wenomics that he thinks will allow him to. give the president what he wants, which is lower  interest rates. Now, Zanny, I know this because. we've talked about Warsh quite a lot over a  number of years. You've known him now for, I don't know, 15 years, something like that.  Yeah. I don't know him well, but I met him when. I had Henry's job. Yeah. Some 15 years ago at at  central banker gatherings where he was sort of,

you know, a swashbuckling figure, but he is he  is a serious he's a lawyer by training, I think, but he was a serious figure, a Wall Street figure.  He knows the markets extremely well. He played a. very important role in the financial crisis of  0809. He was a kind of Ben Bernanke, the then. chair sort of conduit to the markets. But I have  always thought of him as a conservative economist, someone who's extremely hawkish. In fact, he was  hawkish when it was unfashionable to be hawkish, when there probably wasn't much of a reason to  be hawkish. Archie, you've actually been uh doing. some interesting work this week. You've built an  LLM, right, which characterizes the hawkishness.

and doubbishness of of Warsh. Do you want to talk  us through what you found? The question everyone's. been playing with is just how political is Kevin  Warsh, you know, how much is he a kind of classic. technocrat, as he at times, you know, is and how  much is he a really kind of political actor? And. this chart, I think, gets across something pretty  striking, which is, you know, Kevin Walsh is a. hawk. So higher values on this chart mean more  hawkishness. So more anxiety about inflation, more.

desire to pull up interest rates. And for pretty  much all of his career, he's really been a hawkish. figure. And there are a few exceptions. you know,  he was not a hawk in the depths of the financial. crisis. He was not a hawk in the depths of COVID,  but really that's the pattern. And then you see. this remarkable pivot. You see Donald Trump coming  in that line right at the end and then this crash. as Kevin Warsh suddenly reinvents himself  as this rate cutting, easy monetary policy, dovish figure who will deliver the things that  Donald Trump says he wants, much lower interest.

rates. And we'll now see if he does. We've  actually got a question, Archie, for you from. one of our viewers, Graeme Hallwood, who asks, "Is  policy simply decided by one governor equals one. vote majority wins? What influence does the Fed  chair have in theory and also in practice?" Yeah, it's a really important question. So, there's  there's the norms and then there's the rules. So, the rules are that it's it's one member, one vote  on the FOMC. It's the rate setting committee and. that's made up of Fed governors and also some of  the regional bank presidents of of of the regional.

Fed branches in the US. And so usually that's  that's one person one vote. It's generally a. very consensus driven body for the most part. But  in theory in in kind of the rules themselves that. that means that the Fed chair could be very easily  outvoted. And the norm is that doesn't happen. The norm is that usually everyone goes along what  the Fed chair wants. But also the norm is the Fed. chairs pretty technocratic, not very political,  not going on Fox News and catering to the whims. of the president as Kevin Warsh has been doing.  So that's really going to be tests I think as he.

tries to deliver those interest rate cuts. I mean  I I found myself wondering whether it's really. sustainable for a Fed chair to be outvoted by the  majority. I mean Fed chairs it's as you say it's. it's a norm because Fed chairs don't want to be  seen to be at odds with the rest of the the rest. of the committee. I think it's not actually. And I  think Archie, one area where I would slightly take. issue with you, I think successful Fed chairs are  actually incredibly politically astute. They have. to be. Alan Greenspan was a was a remarkable  politician. I think they they are less overtly.

political in the sense that you go on Fox News and  say what the president says, but the politics of. managing to bring the Oh, yeah. the FMC with  you is really important. It's the the small. P politics versus the kind of partisan politics.  And famously, Kevin Warsh is meant to be a figure. who's very, very good at that, but he's really  going to be tested. But it potentially puts Walsh. in a very difficult position. I mean, you know,  he's got he's got Trump on one side who implicitly. he's made promises to in order to get the job.  He's got running the committee on on the other.

side and somehow he has to try and bridge the  bridge these two things. So, a lot of this I think. depends on whether his sort of intellectual gambit  can work. And Henry, in in in simple terms so that. I understand them, can you explain what underpins  this idea that if you have QT, so you have a. balance sheet tightening at the long end that  enables you to loosen short-term rates. And do. you think he can pull it off? Well, they're both  tools of monetary policy. So, it sort of stands to. reason that if you loosen with one hand, you can  tighten with the other. I think the real problem.

with this is that I just don't think and I don't  think many most central bankers think that QE is. that powerful at all. And earlier in his career  in the 2010s, Kevin Warsh was really consern. after the global financial crisis would unleash  inflation. That turned out not to be the case. And I think now he's making a similar error if  he thinks that really shrinking the Fed's balance. sheet, which by the way is quite technically  difficult to do, but probably is doable. if. shrinking the Fed's balance sheet will give him  loads of space to cut rates. I just don't think.

it's that powerful at all. So that that's the  problem I'd have. It's sort of about the quantum. of the effect rather than whether it's there. I I  wonder whether I that that makes good sense to me, but I wonder whether he just doesn't use as a fig  leaf to cut rates. So he says, "What I'm doing, I'm doing QT here. Therefore, I need to cut rates  and then then he uses as a kind of presentational. tool in order to do what Trump wants." And  that's where the rest of the committee comes. in. You know, are they convinced by this argument  or not? So I think my prediction would be that he. talks a lot about radical change at the Fed, about  dramatic changing of its remitt, about dramatic.

changing and and and tightening of cutting of the  balance sheets, but actually doesn't do as much as. the short end as people expect. And I think that's  what the market are expecting, right? That's what. people are assuming that there isn't going to be  as much doveness as people expect. But but where. are you, Henry, on that? I I think that we should  take him on his word and that we will get more. short-term interest rate cuts than we would do  with Jerome Powell in office for sure. It's true. the markets didn't move very much, but you know, I  think we should take him at his word on that. So, do you think independence is is at risk now?  Well, that's not quite the same thing. I think.

we might get more inflation on account of that.  I don't think the American economy looks like. it needs a lot of short-term interest rate cuts  as we were saying. Uh, I think Walsh, especially. as Trump gets weaker during his presidency, it's  not going to be in the pocket of the president, but just in terms of what you get right now, I  think you get more rate cuts than you do under. power. Let's ask Archie where he comes out having  done this deep dive into into every word that. uh Kevin Walsh has ever said. I'm not going  to try to kind of predict the soul of the man, much as that would be quite entertaining to do.  But no, I I think that the exact question is can.

he bring the board along? And his career suggests  he's very very astute at that. But I think even if. he does that, you get easier policy than Jerome  Powell. I think that's that's definitely true, but not by that much. I'd guess he'd bring one  or two extra rate cuts than you'd get if you. stuck with Jerome Powell. But Trump says he wants  interest rates down by a full percentage point, two or three percentage points. That's really,  really hard to see. He's been nominated, but. he obviously he has to get through the Senate. and  Senator Tom Tillis uh who has basically said he is.

not going to allow any nominations through until  the investigation into criminal investigation into. Jerome Powell is lifted. Could you just tell us  Archie where you think that's going to end up? I I really can't see the Senate ultimately being  an issue. So absolutely Tom Tillis is saying this. usually a Department of Justice investigation  like the one that's been launched into the Fed. is very arms length very independent from the  president once it's rolling kind of is rolling. but that's not what's going on this investigation.  It's very clear this is a politically motivated.

investigation that ultimately stems from the  desires administration. So just as they can turn. it on and they have they can turn it off and it's  going to be difficult require a bit of deafness. but Trump's already distanced itself from this. I  mean, this was a a bit of a disaster when it was. rolled out and there was a huge backlash, not just  from Tillis, but from a lot of Republican senators. who are usually quite loyal to the president and  so it'll require a slight dance, but ultimately. I I really struggle to see anything other than  Kevin W sailing through. Yeah, I think they've got.

to maybe sort this out. They're bound to sort it  out out of thought. But the the the kind of side. effect I think could be that the more Trump more  reluctant Trump is to back off and the more this. carries on, the more likely that Jay Powell will  exercise his right to remain on the Fed board, which goes back to our earlier conversation about  how easy it is for Walsh to carry the board with. him. So I think this this will be resolved,  but it could end up backfiring for Trump.