Donald Trump’s nomination of Kevin Warsh to lead the Federal Reserve will trigger a sweeping reappraisal of the central bank’s role at the centre of the world’s biggest economy, leading economists have said.
Warsh, a former Fed governor, has spent years criticising the central bank for what he views as mission creep as policymakers expanded their toolkit to fight against the ructions wrought by the 2008 financial crisis and the coronavirus pandemic 12 years later.
It is those calls for “regime change” that helped win over Treasury secretary Scott Bessent, who has similarly decried the Fed’s “gain of function” in recent years.
Now, Warsh is poised to lead an overhaul of the institution from its helm, subject to the Senate approving his appointment.
“The administration, especially Bessent, is taking on a really broad view of what can be changed at the Fed,” said Derek Tang of research group LH Meyer. “A new chair is just the first part of that story.”
The Fed’s vast bond-buying programmes, which Warsh initially supported as a Fed governor during the financial crisis, are at the centre of the Trump administration’s allegations that the central bank is acting far beyond its remit to keep prices in check and maximise employment. The sprees, known as quantitative easing, expanded the Fed’s balance sheet from less than $900bn in 2008 to a peak of almost $9tn.
The balance sheet now stands at $6.6tn, following a three-year reversal of QE — dubbed “quantitative tightening” — that the rate-setting Federal Open Market Committee has recently paused amid signs banks were falling short of reserves.
Warsh has said he would like to shrink it much further — a move that would raise tensions with rate-setters still scarred by the violent market reaction to their attempts to lower their holdings of government debt in 2019.
Warsh in April said successive QE programmes meant politicians found it “considerably easier appropriating money knowing that the government’s financing costs would be subsidised by the central bank”.
Some prominent former central bankers — such as Raghu Rajan, a University of Chicago professor and former head of the Reserve Bank of India — agree that the Fed may have strayed into the Treasury’s and Congress’s domain.
“When the government needs a lot of financing and you’re buying a lot of Treasuries, how long can you maintain the fiction this is monetary policy, not fiscal financing?” Rajan, who like Warsh is a member of the Group of Thirty think-tank of current and former top financiers, told the FT.
But Jason Furman, a Harvard economist who served in former President Barack Obama’s administration, warned that “markets have a way of telling you what you can and cannot do”. Investors say any big move to reduce the Fed’s Treasury holdings could increase long-term borrowing costs.
“[Warsh] has a deep-seated belief in shrinking the balance sheet, but I am not sure it’s going to work,” Furman said.
Warsh’s warnings on QE have rankled with current and former Fed officials, who still see asset purchases as part of their standard toolkit to keep inflation close to their 2 per cent goal.
Officials are also angered by Warsh’s claims that their response to the pandemic “was the biggest monetary policy error in 45 years” and attempts to paint their approach to data collection as too backward- looking.
Along with shrinking the balance sheet, Warsh would like to change the Treasury-Fed Accord, a 1951 agreement seen as the foundation for the US central bank’s freedom to set interest rates free from political pressure.
Warsh has said he wants a “recommitment” to the accord that would entail a smaller, less powerful central bank, with some control of its balance sheet handed to the Treasury.
Carol Tomé, chief executive of UPS, where Warsh is a board member, also believes Trump’s nominee will push the Fed’s staff to gather more “real-time information” to rely less heavily on official government data that comes on a longer lag.
“I would think he’d be moving the system in that direction because he’s seen the power of it,” Tomé told the FT.
He could also deploy economists to find out whether his view is right that an AI-led productivity boom can boost US workers’ pay without stoking inflation — a move that could potentially pave the way for more interest rate cuts.
“There’s such transformational things happening in AI, robotics and life sciences,” said Mohamed El-Erian, a professor at Wharton. “He’s going to have one of the best economic staff there and he’s told us that he wants to redirect a lot of the central bank’s efforts in that direction.”
But rank-and-file staff are concerned that Warsh’s links to the Trump administration, which has sharply reduced federal employment, mean he will try to slim down the Fed as part of his overhaul.
Michelle Bowman, another Trump appointee who last year became vice-chair for financial supervision, has unveiled plans to chop the Washington-based board’s supervisory staff by 30 per cent.
“There are some real questions about what his approach to staffing is going to be and how he will use the Fed staff,” said Michael Strain, a former New York Fed economist now at the conservative American Enterprise Institute think-tank.
Some say a Warsh-instigated revamp is in the Fed’s interests, potentially quelling the Fed’s very public spat with the White House, which has sharply criticised the central bank for not sharply cutting rates.
“His mindset is that if you don’t reform the Fed from the inside, people will try to reform it from the outside,” said El-Erian, another Group of Thirty member.
Others say the ferocity of his barbs — and the hostility within the US central bank to an administration that has placed current Fed chair Jay Powell under criminal investigation — will make it difficult for him to impose his stamp on the institution as quickly as he and Bessent desire.
“Warsh’s intent is to restructure the Fed and to revamp the way that it thinks about the economy, the models and the actual framework that it uses,” said Krishna Guha, a former New York Fed official who is now a vice chair at Evercore ISI. “It’s something that is going to be hard to proceed with very rapidly.”
“If he approaches this in the spirit of Maga regime change, it will maximise resistance and opposition from the vast majority of the others in the system,” he added. “If, however, he approaches it in good faith as an exercise of trying to reform and improve the way the Fed operates, he could generate a lot of buy-in.”
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