MNI INTERVIEW: Warsh Fed Won’t Manage To Ease Soon-Hubbard

The Federal Reserve’s incoming chair Kevin Warsh would have a tough time convincing an increasingly hawkish FOMC to go along with rate cuts at a time when a large energy shock is creating fresh fears of inflation, former White House Council of Economic Advisers Glenn Hubbard told MNI. 

“It would be hard to believe that the Fed could cut rates immediately given all the obvious pressures on inflation and the fact that the real economy is still fairly solid,” said Hubbard, who served in the CEA alongside Warsh before he became a Fed governor.  

Warsh has previously hinted that he would back lower interest rates by touting the prospect that strong AI-led productivity could allow for more non-inflationary growth. But Hubbard thinks the outlook is more nuanced, while the conflict in Iran has added to uncertainty.

“Eventually, yes, the AI boom is, of course, a productivity boom, and it's probably disinflationary. In the near term, AI is adding a lot to aggregate demand, data centers and hard capital build out, that's going to put upward pressure on the real interest rate and possibly inflation. You have to be a little bit careful. Any story about AI shouldn't be an argument for cutting rates now,” said Hubbard, now a professor at Columbia Business School. 

He said mission number one for Warsh as he rejoins the central bank will be to develop a strong rapport with the institution and its many layers of staffers.

“The first step for Warsh will be to build relationships with other governors and members of the FOMC. Sometimes people forget the chair is not a king. It's a consensus organization. And as part of that, I think he'll have to have a theory of the case, if you will, for the short run, the medium run and the long run,” said Hubbard.

“The only argument for cutting rates in the near term would be if you thought the economy had weakened markedly and inflation is behaving. But neither of those seems true.”

The Fed this week held rates steady but three Fed presidents dissented against the statement because they thought language that is perceived as an easing bias is no longer appropriate. (See MNI INTERVIEW: Fed Hawks Right To Focus On Inflation - Harris)

BALANCE SHEET

As to the Fed’s large balance sheet, of which Warsh has been a long-time critic, Hubbard also does not expect immediate drastic action. 

“It would have to be gradual, more complicated than whether you want the Fed to have a big or small balance sheet. There's two discussions that get conflated. One is, as Warsh put it in his testimony I think, is staying in your lane, not having too big a footprint in the economy, I appreciate that. And we also have a lot of regulations that have neutered the ability of private market makers to maintain liquidity in the Treasury market,” he said. 

“I think you'd have to go pretty slow on shrinking the balance sheet and at the same time, maybe make regulatory changes to bring those market makers back. So I wouldn't expect him to make any radical changes.”

COMMUNICATIONS

Hubbard strongly supports the changes to communications that Warsh has called for, he said. (See MNI POLICY: Warsh Could Reshape Fed On Rates, Communications)

“I’m 100% with him on both the dot plot and forward guidance. I don't think they've served the Fed well. I also think that communications need to be more coordinated,” said Hubbard.

“I think we've had entirely too much discussion in the open from other Fed officials, policy disagreements. I think the Fed needs more discussion inside the room, but less discussion outside the room.”