Donald Trump has finally nominated Kevin Warsh to succeed Jerome Powell as head of the Fed next May. He must be confirmed by the Senate.
Warsh has already worked at the US central bank. He was a governor from 2006 to 2011 and worked closely with Ben Bernanke, the Fed chairman, on managing the financial crisis that shook the global economy.
He is known, until now, as a conservative with a strong bias toward inflation. He has indicated on numerous occasions that his hierarchy of objectives for the Fed prioritizes meeting the inflation target over the economic activity target. Consequently, according to his somewhat older statements, he prefers higher interest rates to lower ones.
He indicated that the central bank had reacted too late to the inflationary wave. According to this central banker, interest rates that are too low for too long are destabilizing.
If we were to use the usual markers of members of central bank monetary policy committees, Kevin Warsh would lean more towards the hawks than the doves.
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But his position has recently evolved. His initial preference for high interest rates to prevent inflation from spiraling out of control has shifted toward a view more aligned with Washington’s position. Ultimately, to support economic activity, particularly household lending, lower interest rates would make sense, according to whoever is likely to succeed Powell.
He also wants to refocus economic policy efforts on the White House rather than the Fed’s strategy. He aims to reduce the size of the central bank’s balance sheet to prevent excessive financialization of the economy. The real problems are addressed at the White House, and the Fed will simply support them.
He also shifted his stance on the issue of independence. From a formal approach that favored independence, his viewpoint evolved, as he now places the Fed’s actions lower in his hierarchy than those of the White House.
There are several points to consider.
1-We do not yet know the mission letter that Kevin Warsh will take in his pocket to the Fed after receiving his instructions in the Oval Office.
The likely future president is a hawk, at least on paper, which should reassure investors. But his recent behavior shows a bias toward Donald Trump’s policies. While he may not drastically lower interest rates, he could do so gradually.
2- This credibility, acquired through his time on Wall Street and at the Fed, is important because the Treasury will have to issue a lot of bonds in the coming months and years (the public debt-to-GDP ratio will tend towards 150% by 2050, according to the Congressional Budget Office). The recent volatility of the US bond market at the time of the Greenland announcements is a stark reminder. Trump took this into account by softening his stance on the issue.
3- The Genius Act should enable the development of stablecoins and thus broaden the dollar’s reach worldwide. An overly risky monetary policy could make investors wary of US assets. This would then be counterproductive to the financing of US debt by the world.
4- The key issue remains the mission statement. We want rational arguments, but there have been no shortage of surprises in American politics over the past year.
