Kevin Warsh Needs to Keep the Fed Out of Politics — No Matter What Trump Says

Trump’s calls for sharp interest-rate cuts have, understandably, left many concerned that this appointment comes with an implicit understanding that the Fed must immediately lower rates.

Congress should use the window of opportunity Warsh’s appointment presents to pass legislative reforms that help shield Fed independence and improve economic outcomes.

The Fed chair can hold more sway than other board members in setting the direction of the organization and focusing on areas for improvement. Warsh therefore could have a big impact on the central bank’s policies.

But when it comes to interest-rate decisions, the chair is just one of 12 voting members of the Federal Open Market Committee, the body responsible for setting the Fed’s rate target. As such, investors should not think that this appointment means that Trump will have greater influence over interest-rate decisions. Indeed, during his tenure as an FOMC member, Warsh never dissented against the committee even when he held a difference of opinion. Consensus building is part of the chair’s job, and people should expect that to continue under Warsh.

Given that caveat, it is important to take stock of Warsh’s views to gauge the future direction of the central bank. Some of these views might help determine whether Chair Warsh would make Fed policy better or worse.

Warsh’s best and most consistent policy view is his opposition to quantitative easing (QE). He served on the board of governors when the Ben Bernanke-led Fed began this large-scale asset-purchase program. Despite voting with Bernanke for the program, Warsh expressed concern that an expanding Fed balance sheet would distort financial markets — prescient given the Fed’s further rounds of QE since and its deleterious effects. Warsh has continued to advocate for a smaller balance sheet that would allow monetary policy to revert to its pre-2008 system that, while imperfect, is far better than now. As it stands, the Fed is currently around 30% the size of all U.S. commercial banking.

Warsh has also criticized the Fed’s mission creep, and he’s right to do so. The Fed cannot fix everything, and trying to do too much only serves to detract from its core mission. He has criticized the Fed’s foray into political issues like climate change and its now-infamous reinterpretation of maximum employment as a “broad-based and inclusive goal.”

Doubtless, as Fed chair, Warsh will be pressured by politicians to help with ballot-box issues. He should stand firm on principles and reject Fed involvement. Crucially, this also means standing up to the president, who wants the Fed to reduce the exorbitant interest expenses resulting from the national debt. But that is not the Fed’s job — the government must cut spending and not look to the Fed.

The Fed’s ever-expanding role as a financial regulator has also detracted from its monetary-policy objectives. Warsh has criticized the regulatory regime which restricts U.S. banking with a convoluted and overly intrusive set of rules, recently stating that the “Basel endgame isn’t America’s endgame.” The Fed does not need to be a regulator to conduct monetary policy and at least two other federal financial regulators (the OCC and FDIC) can subsume the Fed’s regulatory powers. Warsh should fight against the Basel regime in favor of a simpler, less burdensome system.

Yet not all of Warsh’s stances offer a positive outlook for monetary policy. For instance, he rejects rules-based monetary policy, stating in 2018: “I do not favor conducting monetary policy by fidelity to a fixed policy rule.” I have written about the numerous benefits such policy offers; suffice to say, several problems with the Fed, including those Warsh identifies above, can be alleviated by following a monetary-policy rule. He has also advocated for the U.S. to adopt a digital dollar DXY‑0.09% for wholesale currency transactions. While not as bad as a retail central-bank digital currency, a digital U.S. currency still marks a massive intrusion by the government into citizens’ financial freedoms.

Warsh has been willing to critique his future Fed colleagues to defend the administration in the recent past but, hopefully, that is political gamesmanship rather than a sign of things to come. With debt costs continuing to rise and economic data at odds with severe rate cuts, it is unlikely that the pressure on the Fed will cease, even with Warsh at the helm.

Ultimately, Warsh’s success as Fed chair will rest on his ability to withstand political pressure and navigate the Fed toward more objective policymaking that turns rate decisions into a predictable and transparent process.

Warsh has a better chance than Fed Chair Jerome Powell or former Chair Janet Yellen to implement such serious reform. Most Fed chairs have marketed themselves as a continuation of their predecessor’s work for the market stability such a perception brings. Instead, Warsh has positioned himself as a “regime change” candidate. There is more support for drastic change given the Fed’s recent mistakes and the media attention that has garnered. But, all things considered, it’s doubtful that any serious changes will be implemented by changing the Fed chair alone.

Assuming Warsh becomes Fed chair — and this is not a given, as some Republicans are hesitant to appoint a new Fed chair while current Chair Jerome Powell remains under federal investigation — the force of reversion to the status quo will likely be too powerful. Take QE as an example: We were assured that it was a temporary measure when first implemented. It has been almost 20 years since, and massive asset purchases that were once an unconventional monetary-policy tool are now standard practice.

It will be too tempting, and too easy, to interfere in asset markets once again at the first sign of economic distress. And Warsh’s tenure as governor already records him voting in favor of QE despite his reservations.

True monetary-policy reform must come from Congress. There are positive signs: The House Financial Services Committee has formed a monetary-policy task force, and hearings have been held on various aspects of the Fed’s operating system.

But these efforts need to go further. It will be harder to implement reforms if Warsh must spend a significant amount of his time staving off political attacks and the president’s demands to lower rates.