He’s Not the Worst Kevin

The best available Fed endgame likely ends with confirming Kevin Warsh, but moderate senators should first keep pushing the administration to end DOJ interference in monetary policy.

Dear readers,

Before Donald Trump made everything weird, there was already a partisan divide over the Federal Reserve that had emerged in the aftermath of the global financial crisis.

As the economy struggled to recover in the years after the 2008 crash, the Fed undertook extraordinary measures to support a sagging global economy. Most obviously, it held short-term interest rates at zero for years. It also took two categories of novel actions to push down long-term interest rates: forward guidance, which involves the Fed telling market participants it intends to keep rates low for an extended period; and quantitative easing, a policy of buying long-term bonds in vast quantities so their yields fall in the market. During the Obama presidency, Democrats tended to argue that these policies were effectively serving the Federal Reserve’s dual mandate of promoting maximum employment and stable prices — that extraordinary economic conditions required extraordinary action to prevent deflation and depression. Republicans claimed this was all unnecessary, and that the Fed was artificially inflating asset prices, “debasing” the dollar, and ultimately would cause great inflation.¹

While these debates were heating up, Kevin Warsh was serving as a member of the Federal Reserve Board of Governors, having been nominated by George W. Bush in 2006. During his time on the Fed board, and also thereafter, Warsh has generally been a hawkish voice on monetary policy. He has been especially critical of the expansion of the Fed’s balance sheet, publicly breaking with the Fed over its quantitative easing program in 2010 and then resigning from the Federal Reserve Board in 2011. Even as his views on short-term interest rates have changed in recent years, he has continued to urge the Fed to “significantly” reduce its balance sheet, which has now come to contain trillions of dollars in assets.

Warsh’s views were the orthodox stance for a Republican monetary policymaker to hold post-2009, and he was considered a likely candidate to chair the Federal Reserve if Mitt Romney won the 2012 election. He was also on Donald Trump’s short list of possible Fed chair candidates in 2017. But Trump has never wanted an orthodox monetary policymaker — he just wants low interest rates, which he was more likely to achieve through continuity with the Bernanke-Yellen approach than by appointing someone more hawkish. As I wrote in my 2020 profile of Jerome Powell for New York magazine, this is why Powell became Fed chair: He was the one available Republican who was tall, with the right kind of hair, appropriate experience, and an intention to continue Yellen’s policies instead of tightening them. Warsh, the president correctly assessed at the time, was too much of a hawk to do what he wanted.

Now, Trump has nominated Warsh to be Fed chair, having apparently decided that he has aged into the role and no longer looks too youthful. (Warsh is 55.) There’s also a widespread sense — held by many more people than just the president — that Warsh has undergone a convenient shift in his policy views and has now become a dove who wants the loose monetary policy Trump demands. Nonetheless, Warsh is a well-established fixture in the monetary policy-making community (which is a thing), and he’s been earning endorsements from the likes of top Obama administration economic official Jason Furman and Canadian Prime Minister Mark Carney, himself a former governor of the Bank of Canada and the Bank of England.

There is an important asterisk associated with Warsh’s dovish turn. Yes, he now wants to cut short-term interest rates more than most sitting members of the Federal Open Market Committee² would like to. But he also keeps calling for the Fed to greatly shrink its asset holdings. And indeed, after Warsh was nominated, the dollar strengthened, long-term bond yields rose, and precious metals declined; these are all signs that the market takes seriously the prospect that Warsh would move the Fed toward selling off assets and therefore doing less to hold down long-term rates. In other words, market participants don’t appear to believe Warsh has actually quit being a hawk.

As Fed Board member Stephen Miran correctly explained on Bloomberg TV last Friday, rate cuts and shrinking the balance sheet are policies with counteracting effects. If the Fed cools the economy by selling bonds, it can offset those effects by cutting short-term interest rates; if matched correctly, the offsetting policies need not produce any net stimulus or de-stimulus of the economy. You can also look at this the other way around: A Fed that cuts the Federal Funds rate in the way the president clearly wants could avoid overstimulating the economy by selling assets at the same time. But this combination of policies wouldn’t have the sugar-high effect the president clearly desires from rate cuts. In fact, you should tend to expect that longer-term interest rates — including mortgage rates — would go up.

I think — and the market also seems to think — there is a significant likelihood that Warsh is exploiting the president’s shallow understanding of monetary policy, in which Trump fixates solely on the Federal Funds rate and probably does not devote much time to thinking about the Fed’s balance sheet, thus causing him to misunderstand how dovish Warsh’s overall philosophy really is.³

On the other hand, there are major practical barriers to achieving a significant near-term shrinking of the Fed’s balance sheet. The Fed needs to hold a lot of assets because it has a lot of liabilities in the form of reserve deposits that banks make with the Fed — if a bank deposits money at the Fed, the Fed has to turn around and invest it in something. You could loosen bank regulations to reduce the amount of reserves banks hold, but that couldn’t be done overnight and would require a consensus on the Fed board. There’s also the issue that shrinking the Fed’s balance sheet is a contractionary policy, and a lot of people will lose their minds if Warsh is able to push through a program of asset sales and long-term interest rates — including mortgage rates — spike as a result.

More broadly, stubborn realities about how Fed policies actually affect inflation and interest rates would be a barrier for any Fed chair who hopes to sharply change policy — whether by cutting rates deeply like Trump wants or by selling off lots of assets in a way he’d likely end up hating — and are a reason to bet on more policy continuity at the Fed than Trump surely hopes for. And that’s before even discussing the fact that a new chair is just one vote among 12 on the FOMC.

Given all that, should someone wary of the president’s efforts to undermine Fed independence and push an inappropriately loose monetary policy want to see Warsh confirmed? From a policymaking perspective, I tend to share Furman’s view that Warsh is the best we’re likely to do under this presidency. But there’s an important issue beyond interest rate philosophies. The administration’s clearly telegraphed desire to assert more direct control over the Fed, including through misuse of the Department of Justice to criminally investigate Federal Reserve Board members the administration finds troublesome, is a reason not to want to let Trump put more people on the Federal Reserve Board.

Republican Sen. Thom Tillis, whose vote is needed to move Warsh’s nomination out of the Senate Finance Committee, says he won’t advance any nominee for any position at the Fed until the Trump administration makes clear it’s giving up any effort to use pretextual DOJ action to pressure Powell to either change his policy stances or resign his board seat before his term ends in 2028. I share Tillis’s outrage — and the outrage of most congressional Democrats — at the president’s weaponization of the Justice Department. And I think the blockade is worth a shot.

But I think it’s worth considering what might ensue if the Tillis follows through, the White House does not back down, and no one is actually confirmed to the Fed before Powell’s term as chair expires in May.

If the Fed chairmanship became vacant, Trump would likely assert the authority to name an acting chair from among the sitting members of the Federal Reserve Board; there is legal ambiguity here, but Trump would be able to point to a precedent from the Carter administration. Meanwhile, the FOMC would be able to elect its own chair. By convention, the Federal Reserve Board chair also serves as FOMC chair, but the FOMC does not have to follow the convention if it doesn’t want to.

If Trump were smart, he would designate Christopher Waller, one of his first-term appointees to the Fed Board who has been somewhat more inclined toward rate cuts than most other policymakers at the Fed, as acting chair. Waller has made a non-crazy case for those rate cuts and has credibility with his colleagues that might help him lead the Fed in a modestly more dovish direction. I doubt there would be any controversy about installing Waller as the head of the FOMC.

But I suspect what Trump might do instead is designate Miran.⁴ Last September, Miran took a leave from his role as Chairman of the Council of Economic Advisers to serve a short, Senate-confirmed stint on the Federal Reserve Board, replacing a Biden appointee who resigned shortly before the end of her term. Miran has advocated a more aggressive course of rate cuts than Waller has and is more severely out of step with the rest of the board and the Fed’s regional bank presidents; he’s also very closely associated with Trump and would have much less credibility as an independent actor than either Waller or Warsh.

Technically, Miran’s term at the Fed ended on Saturday, when his appointment to the board expired. Warsh has been nominated to take Miran’s seat on the board, in addition to the board’s chairmanship. But the Federal Reserve Act permits Miran to remain in his board seat until the Senate confirms his replacement, rendering Miran available as an acting chair designee. Miran has now officially resigned from his role running CEA in anticipation of a more extended tenure at the Fed. As such, the fact that the Senate already confirmed Miran — with Tillis’s vote — poses a significant tactical problem for any effort to blockade Trump’s Fed nominees. Unless Powell agrees to resign from the Fed board, Trump will have the same number of designees sitting on the board whether the Senate acts on the Warsh nomination or not; the Senate only gets to decide whether Miran or Warsh will be the Trump designee with power at the Fed.

A protracted vacancy in the chairmanship would be chaotic and uncomfortable for both the president and those who would defend the Fed from him. Likely conflicts between an acting chair Miran and the rest of the FOMC, which he might not even chair — and the resulting uncertainty over the direction of monetary policy — would both unsettle markets and undermine the Fed’s ability to respond to market troubles. The president wouldn’t like that, and I think a blockade (or even just a threat of a blockade) might be an effective way to pressure him into calling off the DOJ.⁵

But the protracted period without a confirmed Fed chair would also increase the threat to Fed independence. A FOMC perceived as rudderless and divided won’t provide a great advertisement for the need to insulate the Fed from political control by the White House. And if Republicans in Congress — many of whom have spent years working hard to finesse this issue — are increasingly forced to choose between their support for the president and their support for Fed independence, a lot of them will choose wrong.

All of which is to say, it will behoove both Trump and Tillis to find a way to get to yes on Warsh. Democrats won’t have a say in the matter, but I think they too should root for an accord.

That doesn’t mean that Democratic senators should vote for Warsh. But I do think the main problem with Warsh is just as likely to be the normal one — he’s too hawkish, in the way we would have expected from a Fed nominee in a Romney administration — as it is to be the weird problem of him being inclined to inflate to make Trump happy.

Very seriously,

Josh

1. Of course, we did eventually get a material bout of inflation — not the apocalyptic kind of bout I heard a lot of warnings of circa 2011 — when Congress and the Fed managed to overdo the fiscal response to COVID. But the much-predicted inflation from the global financial crisis response never emerged.

2. The FOMC, which sets the Federal Funds Rate and makes decisions about the Fed’s balance sheet, is a 12-member body consisting of all seven members of the Federal Reserve Board, the president of the Federal Reserve Bank of New York, and 4 of the other 11 regional Fed bank presidents, who serve on a rotating basis.

3. I think this clip of Warsh on Fox Business from last October is instructive: economist Justin Wolfers has highlighted the clip for the way Warsh kisses Trump’s ass, bashes the Fed, and talks with uncharacteristic enthusiasm about short-term interest rate cuts. But what policy does Warsh keep prescribing in the clip? That the Fed should shrink its balance sheet. Warsh demagogically describes this as “redeploying” money from Wall Street to Main Street, but both Warsh and the market know this is a hawkish policy that would raise long-term interest rates on both Wall Street and Main Street.

4. If the president had a full understanding of Waller‘s virtues as a candidate for Fed chair, he would probably have nominated him to be the chair.

5. Indeed, the outrage in the Senate over the DOJ’s subpoena to the Fed — and negative market reaction — already seems to have successfully pressured the president into changing course. A couple of weeks ago, he looked primed to name his economic adviser Kevin Hassett to chair the Fed. While Warsh is not who I’d pick to lead the Fed, he’s clearly the better of the two Kevins — Hassett is not only too close to Trump, he also lacks relevant experience and doesn’t have the ties and relationships that Warsh does. We’re seeing those pay off for Warsh today in the form of institutional support for his nomination, and they would matter once he’s in the chairmanship, in that he’d be much better positioned to coordinate international response to a financial crisis.