MNI INTERVIEW: Warsh Fed Reform Agenda Faces Hurdles-Gagnon

Federal Reserve nominee Kevin Warsh will have a hard time convincing the FOMC to take up his ambitious agenda for central bank reform, including the idea that higher productivity led by AI will allow officials to lower interest rates without risking inflation, former Fed board economist Joseph Gagnon told MNI. 

“Warsh remembers with approval Greenspan's persuasion of the FOMC to hold off on rate hikes during the rapid growth of the dotcom bubble. That was the right move then,” Gagnon said in an email exchange. 

“But to hold off on hikes because the potential growth rate has risen is not the same as to actively lower rates. Warsh says higher productivity growth lowers inflation, but that is true only in a fixed money supply (or gold standard) world. If anything, rapid productivity growth raises the neutral rate.” 

Fed officials have recently signaled they are in no rush to cut rates again as the energy shock from the Iran war compounds the boost to inflation from tariffs. Some policymakers indicated at the March meeting they would like the central bank to acknowledge the possibility that the next move might be a hike rather than a cut.   

“I think he would have difficulty persuading the FOMC on this point,” said Gagnon.

BALANCE SHEET

While Warsh may have some success in persuading his colleagues to shrink the Fed’s balance sheet in order to reduce the central bank’s footprint in financial markets and allow for further cuts in official interest rates, this process may prove slower than the incoming chair might hope, according to Gagnon. 

“Warsh does not like the Fed to hold MBS or long-term Treasuries except in emergencies. He would like to wind those positions down faster than the current plan. He recognizes that that would tighten financial conditions and that would allow him to lower the funds rate to keep conditions constant,” said Gagnon.  

“He may persuade his colleagues to move in this direction, but I doubt they would agree to sell those assets fast enough to justify more than 25 or 50 bp of cuts.” (See MNI INTERVIEW: Warsh Signals Caution On Balance Sheet Plans)

COMMUNICATION 

Warsh could also have trouble in his push for less reliance on forward guidance, including a clear distaste for the central bank’s quarterly Summary of Economic Projections and what he sees as too frequent speeches from regional Fed presidents, Gagnon added.  (See MNI POLICY: Warsh Could Reshape Fed On Rates, Communication)

“Warsh does not like the dot plot. I disagree. Markets have learned that the dots are not a promise. More communication is better than less. Less communication harms accountability,” he said. “I think Warsh will have difficulty persuading the committee of the above and also persuading them to talk less.” 

As for current Fed Chair Jerome Powell’s future at the central bank, Gagnon said there is still a chance that he remains chairman past the end of his term in May.

“Powell will surely stay on until the DOJ drops its investigation and possibly even longer. There is a risk the FOMC could elect Powell as chairman and not Warsh, since Chair of the Board is separate from Chair of FOMC,” he said.