Kevin Warsh’s Federal Reserve inauguration does fewer things better

Just five days after Kevin Warsh’s first press conference as Federal Reserve chairman, Alan Greenspan, one of his predecessors, died at age 100. It is, to some extent, a passing of the torch. Warsh made it clear on June 17, in his first interaction with the press, that he is a reform-minded Fed chairman, laser-focused on today’s cost-of-living crisis and undoing the two decades of bureaucracy that have been built up at the Fed since Greenspan.

Warsh first joined the Fed as a member of the Board of Governors just after Greenspan retired from the chairmanship in 2006, ending nearly 19 years at the central bank’s helm. The “Maestro” certainly had his flaws, but he steered the Fed through the productivity boom of the 1990s without falling into the Keynesian trap of thinking economic growth causes inflation.

Refreshingly, Warsh agrees, and he’s taking the helm at the Fed just in time.

For those who long believed the Fed lost its way, Warsh’s first press conference was the most encouraging thing to come out of the Eccles Building in years. Before his nomination, he repeatedly called for “regime change,” and his critics assumed it was rhetoric — but it’s reality.

Firstly, the policy statement that accompanied the decision to hold rates was dramatically shorter, stripped of the hedging boilerplate of recent years, and it ended not with a wishful thought on inflation, but with a definitive: “The Committee will deliver price stability.” The press conference itself was also leaner, and Warsh declined to go down forecasting rabbit holes or pretend the central bank possesses a crystal ball. But his regime change will go much deeper than eschewing forward guidance.

For years, the Fed has behaved like a sprawling temp agency for academic researchers who increasingly ventured into what were, at best, monetary-adjacent fields while building models that require a level of precision that no central bank could achieve. It’s part of what Warsh has called mission creep.

In 1977, Congress charged the Fed with price stability, promoting maximum employment and moderation of long-term interest rates, but recent Fed chairs have taken their eyes off the prize. They allowed the institution, indeed, sometimes mandated it, to focus on left-wing agendas such as climate change, even incorporating these nonfinancial issues into banks’ stress tests.

These excursions continued as the Fed failed to achieve anything even resembling price stability, costing the Fed credibility, while inconsistent commentary on fiscal policy has made a mockery of so-called Fed independence. Warsh walked in and flipped the tables, announcing five new task forces to fix the broken central bank. Skeptics sneer that task forces are how Washington pretends to act while doing nothing, but they have it backward: each aims for a distinct branch of the mission creep.

The balance-sheet task force confronts the trillions in financial assets that blurred the line between monetary and fiscal policy and turned an emergency measure into a permanent fixture that funnels money from Main Street to Wall Street. The communications task force targets the habit of steering markets through guidance and dot plots instead of letting policy speak for itself.

The inflation-frameworks group reexamines the flawed 2020 doctrine that helped the Fed misjudge the worst price surge in four decades and still plagues Fed decisions today. The remaining two, on data sources and on productivity and jobs, aim to restore the rigor that has ironically gone missing since the Fed began employing so many academics.

The throughline is a return to first principles and a “family fight” worth having: a central bank that does fewer things and does them well.

Another highlight of Warsh’s first press conference was his quiet repudiation of the inflation-unemployment trade-off that has haunted monetary policy for half a century. He rejected the flawed Keynesian framework that tells a country to tolerate more inflation to put more people to work, or that people must lose their jobs to fight inflation.

Warsh correctly rejects the disproven Phillips Curve, the supposed iron law that lower unemployment must buy higher inflation, which has been one of the most expensive ideas in the history of economic policy. It justified the stagflation-era mistakes of the 1970s, when policymakers eased into rising prices on the theory that they were buying jobs, only to get neither low inflation nor durable employment. It taught a generation of central bankers to treat a hot labor market as something to be feared and cooled.

Instead, Warsh understands that inflation is a monetary phenomenon and, more importantly, a choice. He is too familiar with Milton Friedman, Arthur Laffer, and Alan Greenspan to fall for the Keynesian notion that strong growth, low prices, and high employment are somehow enemies forced into a zero-sum game. The productivity boom of the 1990s — which AI is likely replicating today — proved that the Fed doesn’t need to crush growth to prevent inflation.

Nor does the Fed need to play prognosticator. For more than a decade, the Fed has tried to manage markets by telegraphing its intentions — publishing “dot plots” and salting its statements with hints about the next move — only to then rug-pull markets later. Warsh struck the forward-guidance language from the statement and, notably, declined to submit his own projection while encouraging colleagues to continue theirs.

Warsh has made the case plainly: markets work best when they respond to actual economic data, not when they spend their energy trying to decode what the Fed is saying about how it will respond to that data. The reality is that guidance has done exactly the opposite of its intended goal: increasing uncertainty, not decreasing it.

The 2021 “transitory” inflation debacle is just one monument to that failure — a forecast that officials were unwilling to walk back, allowing that stale forecast to calcify into policy, and costing the country dearly. Similarly, when Jerome Powell repeatedly promised the banking sector that rates would stay low for the foreseeable future, banks loaded up their balance sheet with low-interest-rate assets and were caught flat-footed when the then-Fed chairman raised rates at the fastest pace in four decades. The result was a full-blown regional bank crisis in spring 2023.

But perhaps the most important reform on Warsh’s agenda is his intention to reduce the Fed’s balance sheet, which more than doubled — from an already bloated level — to nearly $9 trillion. Powell couldn’t even reduce it to $6.5 trillion before adding to it again as the Fed attempted to maintain its appointed level of bank reserves. For context, on the eve of the Global Financial Crisis, the balance sheet was less than $900 billion, less than one-seventh of its current level.

Warsh has correctly argued that the Fed’s massive bond purchases have done tremendous harm on many fronts, especially by causing inflation. Conversely, shrinking the balance sheet by selling off these financial assets puts downward pressure on inflation by extinguishing the very excess liquidity that caused the problem.

That’s desperately needed after more than five years of inflation running above the 2% target, a record Warsh rightly laments. But he is also being sober and judicious about the pace of unwinding this Gordian knot, acknowledging the problem has been two decades in the making and cannot be unwound overnight. Warsh is humble enough to know his limitations.

Perhaps that’s something he saw in Greenspan, who himself was not infallible, and whose later years carried real lessons about the limits of any chairman’s foresight. That’s a lesson Warsh seems to have taken to heart with the modesty of foregoing forward guidance. He has inherited a Fed plagued by overreach, overconfidence, and overcommunication, but there is reason for hope since Warsh seems to have learned the lessons of his predecessors so as not to make the same mistakes again, but to get the institution back on track. Let the regime change begin.

E.J. Antoni, Ph.D. (@RealEJAntoni), is chief economist at the Heritage Foundation and a senior fellow at Unleash Prosperity.