MNI POLICY: Warsh Task Forces Will Need To Woo FOMC Skeptics

Federal Reserve Chairman Kevin Warsh's star-studded task forces face heavy lifting to overcome institutional inertia and win over skeptical members of the FOMC. 

While some of Warsh's top policy priorities like revising or scrapping the Summary of Economic Projections and shrinking the Fed’s balance sheet have broad support, the notion of relying more on novel indicators or revisiting the inflation framework will likely face stronger resistance -- especially after the FOMC dropped flexible inflation targeting to return to a more traditional regime less than a year ago. 

To keep the panels from reinventing the wheel, each task force is supported by two staffers -- one from a regional Fed bank and one from the Fed Board, MNI understands. Their job is to ground the outside experts in baseline technical data and past debates. 

The task forces start briefing the committee as early as September, with conclusions due by the end of 2026. But they can only make recommendations to the FOMC, which alone decides what changes, if any, are adopted. 

"Ultimately, decisions will be made by my FOMC colleagues," Warsh told Congress last week.

WELL-TRODDEN GROUND

Convincing Fed insiders will be tough because many view Warsh's five lines of inquiry as well-trodden ground. The Fed has already done extensive work on these topics, some of it stretching back years. At the same time, subjects like AI and productivity involve too many unknowns to impact near-term policy. 

And the task forces were designed and selected with little input from other FOMC members. 

Still, the perceived legitimacy of the prominent scholars, business leaders and central bankers picked to lead the task forces, together with their broad range of views, should lend weight and credibility to the recommendations and give Warsh leverage. And the most significant reforms are expected to come in communications and the balance sheet, areas already earmarked for changes after the missteps of the pandemic. 

REFORMS UNDERWAY

Modifying or scrapping the dot plot has been debated for years, and Warsh is finding broad support among colleagues for ditching forward-looking statements. But real reform means clarifying how the Fed explains its reaction function, not just saying less. 

Scenario-based analysis could better communicate how policy might react under uncertain conditions and is likely to be among recommendations from Peter Fisher, Arminio Fraga and Mervyn King. But finding consensus across 19 committee members will remain a challenge, especially with officials increasingly protective of transparency and a regional diversity of views. (See MNI INTERVIEW: Fed Regional Banks Key To Independence - Judge)

Reducing the balance sheet is another discussion well underway inside the Fed, with staffers and policymakers converging on the idea that size should follow function and regulatory changes will have the most impact. 

Karen Dynan, Raghuram Rajan and Jeremy Stein are likely to recommend keeping the ample reserves framework and to float ideas to reduce banks' appetite for reserves. Warsh himself conceded last week that any portfolio reduction will move slowly and deliberately to avoid market dislocation. (See MNI POLICY: Fed Prepares Balance Sheet Options For Warsh)

DATA DOUBTS

The data task force faces potentially the steepest climb. Warsh argues that relying on public data is akin to driving using the rearview mirror. But adopting a shiny new dashboard of more forward-looking indicators would face a problem of optics.

Officials fear basing monetary policy decisions on non-public information risks damage to trust and could lead to the erroneous perception that the Fed holds secret information not available to investors, making market reactions to economic reports more volatile.

Staff economists' use of alternative data has also grown for years as the Fed folded in private statistics, granular spending data and its own surveys to sharpen its read on the economy. Like many private investors, the Fed has picked over proprietary and alternative datasets since the pandemic, but sampling biases and missing seasonal adjustments remain persistent hurdles.