Kevin Warsh's Confirmation Hearing
Four Quick Reactions
Fed independence is a major challenge confronting Kevin Warsh should he be confirmed. Warsh says he will be independent, but he will be at risk almost immediately if confirmed. The President expects Warsh to lower interest rates soon after entering office. If he lowers rates, even for good reasons, he will be accused of being controlled by the President. If he does not lower rates, the President will be highly critical and likely angry.
The Fed’s balance sheet is a second issue for Warsh. In anticipation of Warsh’s confirmation, members of the FOMC are discussing the possible shrinking of the balance sheet, even as it is growing again. However, shrinking it could disrupt liquidity in Treasury and money markets, especially as new debt is growing at $2 trillion per year. The Fed is faced with the problem of fiscal dominance, in which the central bank’s mandate of stable prices becomes secondary to the Treasury’s debt financing needs. The most likely policy discussion will be whether the Fed can stop the growth in the balance sheet. I suspect this topic will be slow to develop for the FOMC despite Warsh’s desire to address it.
Warsh talks a great deal about the Fed staying in its lane. Given how broadly the Fed liquidity safety net has expanded, he and the FOMC will be hard-pressed to convince the markets that it will not step in again should non-bank markets experience a liquidity crisis.
Warsh may have his most success if he proposes to end forward guidance. He is convinced, and perhaps members of the FOMC are as well, that forward guidance has not served policy goals well.