MNI INTERVIEW: Warsh Fed Will See Room For Rate Cuts- Shelton

The U.S. economy is poised for a supply-driven productivity boom that will allow inflation to ease further and give the Federal Reserve room to keep cutting interest rates, Judy Shelton, President Donald Trump's past pick for Fed governor, told MNI. 

Shelton said Trump’s nominee for Fed Chair, Kevin Warsh, will likely face a favorable environment for rate cuts by the time he takes the helm from Jerome Powell, expected in June. She cited the president’s agenda of lower taxes and deregulation as underpinning an expansion that will not boost inflation.

“That will increase productive output, I think that will result in a greater supply of goods and services. That helps to bring down inflation,” she said in an interview.  “It's a lot healthier if Warsh sees increased output bringing down inflation, which is what I would expect. That's a much better way to fight inflation than to try to cut demand through high interest rates.”

She said the current FOMC is focused only on downside risks to the labor market as a possible reason for additional rate cuts, whereas Warsh will likely make a more affirmative case for more easing.    

“I like Warsh’s approach, which I think would be closer to that idea,” said Shelton, a senior fellow at the Independent Institute. “I don't think you  want someone on the Fed who says they want to lower interest rates out of weakness. I think you do it out of strength that as you see good growth and increased productive output and more emphasis on private sector production, then I think you want to do everything you can to enhance access to capital to keep that going.”

ECCLES PARALLEL

Shelton said she also appreciates Warsh’s evolution over the past two decades on matters regarding the Fed’s balance sheet, particularly how he initially supported its deployment as an emergency tool during the height of the 2008 crisis but then was concerned that the central bank failed to pull back on using QE as the emergency faded. 

She likened Warsh's stance to that of former Fed Chair Mariner Eccles in the 1940s. “He had an accord in the sense that the Fed agreed to help finance World War II, because interest was so expensive for the government. But by the time the war was over in 1946, he said we shouldn't keep doing that, I don't want that to become a permanent habit of the Fed,” she said.  

“I see Warsh as being in a similar situation – it was patriotic, say, in 2008 to save the country. And of course, lender last resort is to me the Fed's real legitimate function. But then it's like deploying the airbag, now you have to stuff it back in, get it out of the windshield, and get the car back on the road. And he saw that they weren't doing that and if anything the Fed was increasing its powers.” (See:  MNI POLICY: Long Road To Scarcer Reserves For Warsh)

BALANCE SHEET

Shelton said any effort by Warsh to reduce the USD6.6 trillion balance sheet further, something he has expressed a strong desire to do, would have to be accompanied by moves to lower interest rates. (MNI: Warsh Wants Fed Out Of Treasury's Business)

Active asset sales would be needed to significantly reduce the Fed's portfolio and would force the Fed to recognize losses on securities, putting it deeper into the hole in terms of its missed remittances to Treasury, Shelton said. More importantly, “all that can do is raise interest rates because now you're increasing the supply of Treasuries, and it's going to reduce the price, and that's going to raise the rate," she said.

“This is why I'm waiting for him to say that he would have to reduce the fed funds rate to even neutralize the impact of reducing the portfolio. Those have to go in tandem.”