How a Former Fed Vice-Chair Is thinking About the Next Fed Chair

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• The nomination of Kevin Warsh for Fed Chair is generating unusually split reactions across the economic spectrum, prompting sociological questions about the role itself.  Copied to clipboard!
• The power of the Fed Chair is primarily the power of persuasion, as monetary policy decisions require an affirmative vote from the 12-member committee, though the Chair sets the agenda and engages in extensive bilateral communication.  Copied to clipboard!
• A reduction in post-Great Financial Crisis communication tools like forward guidance, which Warsh has criticized, is predicted to increase interest rate volatility in the bond market.  Copied to clipboard!

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Warsh Nomination Sociological Split

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(00:01:45)

• Key Takeaway: Kevin Warsh’s nomination for Fed Chair has created an unusual split among economists, including mainstream and liberal figures supporting the pick while others strongly oppose it.
• Summary: The nomination of Kevin Warsh is noted for dividing opinion among economists, unlike typical Trump picks. This division highlights internal contradictions, such as Warsh’s past advocacy for regime change versus his speech titled ‘An Ode to Independence.’ The discussion frames the core tension as Warsh balancing his long-advocated overhaul of the Fed with the political reality of his nomination.

Fed-Treasury Working Relationship

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(00:05:37)

• Key Takeaway: Despite Fed independence, a collaborative working relationship between the Fed Chair and Treasury Secretary is practically important for Treasury market liquidity and bank regulation coordination.
• Summary: The Fed Chair and Treasury Secretary traditionally meet regularly, often over breakfast without staff present, to maintain coordination. Furthermore, the Financial Stability Oversight Council (FSOC), chaired by the Treasury Secretary, requires participation from the Fed and other agencies. Coordination is also necessary in bank regulation, where the Treasury’s Office of the Comptroller of the Currency and the FDIC share oversight responsibilities.

Assessing Warsh’s Past Stances

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(00:08:32)

• Key Takeaway: Warsh’s past concerns about inflation during the 2008 crisis should not overshadow his valuable contributions to the crisis response, and his recent dovish shift aligns with the committee’s current trajectory.
• Summary: Warsh’s early anxiety about inflation in 2008 is viewed as challenging but common during crises, and he was highly involved in the successful crisis response alongside Bernanke and Geithner. His historical criticism of the Fed has consistently come from a hawkish direction. However, his recent advocacy for lower rates is consistent with the majority sentiment of the existing FOMC committee as of late 2024.

Role of the Fed Chair in Policy

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(00:13:26)

• Key Takeaway: The Fed Chair’s primary power in FOMC meetings is persuasion, as they only hold one vote, but they influence outcomes by setting the agenda and conducting extensive pre-meeting communication.
• Summary: Monetary policy requires an affirmative vote from the 12-member committee, meaning the Chair’s power is rooted in persuasion rather than unilateral decision-making. Modern Chairs, starting with Bernanke, engage in 18 individual bilateral discussions before each meeting to gauge member leanings. Crucially, the Chair sets the meeting agenda, and the board staff reports to the Chair, influencing the analysis presented.

Forward Guidance Costs and Benefits

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(00:19:35)

• Key Takeaway: Forward guidance became essential when the Fed was trapped at the zero bound to prevent premature rate hike pricing, but its benefits diminish, making a review of its necessity appropriate in normal times.
• Summary: Successful monetary policy was conducted for decades without modern forward guidance under Volcker and the early Greenspan Fed. Forward guidance gained prominence out of necessity at the zero bound to reassure markets the Fed would not hike rates prematurely despite weak economic data. It is entirely appropriate for a new Chair to assess the costs and benefits of forward guidance and quantitative easing, as these tools are not exempt from economic laws.

Impact of Less Forward Guidance

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(00:26:09)

• Key Takeaway: Decreased reliance on forward guidance is robustly predicted to increase market volatility, particularly interest rate volatility, potentially returning the bond market to pre-GFC levels.
• Summary: The decade following the GFC saw suppressed interest rate volatility due to the combination of zero rates, quantitative easing, and extensive forward guidance. As the Fed moves away from this framework, bond market implied volatility (like the MOVE index) is expected to rise toward more normal, pre-GFC levels. This increased volatility is a direct consequence of reduced certainty regarding the future path of interest rates.

Warsh and Balance Sheet Policy

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(00:28:30)

• Key Takeaway: Warsh has consistently criticized the expansion of the Fed’s balance sheet, and his call for a ’new accord’ suggests a potential future negotiation with the Treasury over the size and composition of Fed holdings.
• Summary: Kevin Warsh has been publicly critical of every quantitative easing program since QE1, viewing balance sheet expansion as enabling larger deficits. A ’new accord’ likely implies a mutual understanding on the balance sheet’s size and composition, perhaps restricting holdings to T-Bills. Shrinking the balance sheet is complex because it affects bank reserves, and the current Fed shows no appetite for selling mortgage-backed securities outright.

Critique of Macro Models and Productivity

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(00:36:05)

• Key Takeaway: Warsh’s critique of traditional models centers on an overemphasis on the demand side, suggesting policy must account for supply-side growth driven by productivity, which should not be obstructed by premature rate hikes.
• Summary: The critique is that many macro models overemphasize demand, ignoring supply-side factors like innovation and deregulation that can boost productivity without causing inflation. The Greenspan Fed in the late 1990s eventually hiked rates aggressively (to 6.5% by 2000) despite strong productivity growth, partly due to wealth effects from the stock market bubble. Faster productivity growth inherently raises the neutral rate of interest, complicating near-term policy decisions.

Demonstrating Central Bank Independence

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(00:42:18)

• Key Takeaway: The institutional structure of the Fed, including the requirement for committee votes and historical precedent, is expected to ensure sufficient independence for the Chair to set policy regardless of political pressure.
• Summary: The power of the Chair is persuasion, as they only cast one vote on the 12-member committee, and they set the agenda for meetings. Historical precedent, such as Eccles remaining a thorn in Truman’s side after FDR’s appointment, suggests institutional resilience. The ultimate defense of independence rests on the Fed’s structure and the expectation that courts will uphold its ability to raise or lower rates based on data.

Future of Communication Tools

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(00:53:18)

• Key Takeaway: The new Fed Chair may eliminate modern communication tools like the press conference and potentially Jackson Hole, as these were specific innovations designed for the ZERP era.
• Summary: Communication innovations like the press conference and dot plots were largely developed for the post-GFC period when the Fed needed to convince markets it would remain on hold at the zero lower bound (ZERP). Since that specific purpose is less relevant now, an honest review of these tools is warranted. The prediction is that the new Chair might discard the press conference, as it is a modern, non-precedent-setting feature.