MNI: Warsh Wants Fed Out Of U.S. Treasury's Business

The Federal Reserve should shrink its balance sheet in order to disentangle itself from fiscal affairs and create more room to lower interest rates and boost the real economy, former Fed Governor Kevin Warsh, a top contender to replace Jerome Powell as Fed chair, told MNI. 

Warsh said official borrowing costs should be lower but the exact amount of rate cuts matters less than implementing a wholesale change in framework and communication strategy that restores what he sees as the central bank’s damaged credibility.

“The Powell Fed cut rates last September and mortgage rates went up a full percentage point. That's further evidence the Fed needs regime change, including a new operating framework. When the Fed cuts rates, they should actually go down," he told MNI on the sidelines of an event in New York. 

“Many businesses, households and market participants have come to believe the Powell Fed is actually countenancing a higher inflation rate."

TREASURY-FED ACCORD

Warsh is open to the idea of a new Treasury-Fed accord that would lead to better coordination but also a clearer delineation of powers and duties.

“In a potential new accord between the Fed and the Treasury, the Fed's grand ambitions and bloated balance sheet would be checked,” he said. “The Fed's assets would be reduced in size and scope, and it would materially lower interest rates. And Secretary Scott Bessent's fiscal and regulatory authorities would be strengthened to carry out the president's policies. The real economy would benefit enormously."

The Fed's balance sheet peaked at USD9 trillion after a ramp-up in purchases during the pandemic. It has since declined to USD6.6 trillion but remains much larger than the USD2.8 trillion where it stood when Warsh resigned from the Fed because of his disagreement with QE2.

The former FOMC member, who served on the Board of Governors from 2006 through 2011, again criticized the central bank for what he called mission creep, including forays into climate and social issues, that led it to stray from its mandate of “maximum employment, stable prices, and moderate long-term interest rates.” 

He thinks the Fed’s communications strategy, including a focus on short-term indicators and a dot plot that overpromises on the ability to pinpoint future moves, have been harmful to its credibility, particularly in the wake of a major miss on inflation in 2021-2022. (See MNI POLICY: Fed Takes Measured Approach To Post-Sept Cuts)

"The Powell Fed has made substantial errors in the conduct of monetary policy. They repeatedly forecasted lower prices and delivered higher prices,” said Warsh, a visiting fellow at the Hoover Institution. 

GROWTH MOMENTUM

Warsh said he is not overly concerned about weakness in the labor market despite recent downward revisions to payroll employment gains because those figures are backward-looking and contemporaneous growth measures point to strong underlying economic momentum. 

“Payrolls are a lagging indicator. Modest payroll employment gains reported in recent months reveal the weak state of the economy six to nine months prior.  My view is that the real economy is now accelerating, owing largely to the president's pro-growth policies.  If these policies were not undermined by the Fed, the U.S. would be in the early stages of a long productivity boom." (See MNI INTERVIEW: Treasury’s Lavorgna Sees 3% Growth Into 2026)

President Donald Trump has said Warsh is one of three candidates on his short-list for chair, the other two being National Economic Council Chair Kevin Hassett and Fed Governor Chris Waller.