Warsh War One: The Battle Over QE
This is part 1 of a three-part series examining Kevin Warsh’s nomination to chair the Federal Reserve.
Kevin Warsh’s nomination as Fed Chairman has stirred unease regarding President Trump’s economic policies, drawing concern from both supporters and critics. Many opponents within the Trump administration have quickly conjured a theory suggesting Warsh’s selection was primarily to enforce the President’s agenda. This seems less like a genuine accusation and more like the latest manifestation of a trend some are calling “Trump confusion syndrome.” No longer is it just about “Russia, Russia, Russia”; now, the conversation includes worries over the independence of central banks.
Even some of Trump’s allies, who back his economic direction, appear to have reservations about Warsh being the right candidate for such a pivotal role. Neil Dutta from Renaissance Macro articulated this concern in a podcast, labeling Warsh as “the antithesis of the populist movement that elevated the President.” Furthermore, it feels somewhat surprising to see endorsements for Warsh coming from figures like former Fed Chairman Ben Bernanke and Canadian Prime Minister Mark Carney.
Many analysts may be jumping the gun in categorizing Warsh strictly as a “hawk” or a “dove.” His track record and its compatibility with effective monetary policy might be more nuanced than that.
Warsh is Not a Hawk
Jonathan Levin, a columnist for Bloomberg Opinion, provided a classic example of this widespread misconception, branding Warsh as “a total hawk.” This view largely springs from Warsh’s earlier resistance to a second round of quantitative easing in 2010 when unemployment stood at 9.8%. Levin argues that many who experienced the sluggish recovery of the 2010s now wish there had been more economic intervention, interpreting Warsh’s skepticism as a lack of empathy for the unemployed.
However, this perspective overlooks the crux of Warsh’s argument. He wasn’t advocating for cuts to economic support; rather, he believed that additional quantitative easing wouldn’t address underlying structural issues, potentially prolonging the recovery. According to Warsh, after leaving the Fed, burdens from regulations and fiscal uncertainty were inhibiting investment, and true solutions required efforts to boost productivity and labor force engagement—issues that typically extend beyond the Fed’s responsibilities.
Warsh’s apprehension was not about QE2 being excessive; it was about its ineffectiveness for those on the unemployment rolls. His concern was that while quantitative easing might create some short-term relief, it could introduce market distortions and fuel future inflation. The slow recovery in the labor market throughout the 2010s, along with the emergence of asset bubbles and an increasing reliance on Fed intervention, suggests that Warsh was indeed aware of the limitations of QE.
Growth is Not a Risk to Price Stability
Interestingly, Warsh’s critics from the populist camp may have missed an essential aspect of his perspective: he never viewed growth as a threat. Over the last decade, he has been vocal about the central banks misunderstanding growth as a danger. One of the main culprits he identifies is the Phillips Curve—a flawed model that equates strong employment with imminent inflation.
In 2017, Warsh pointed out, “The central bank’s model assumes that a tight labor market must lead to faster inflation,” questioning the validity of this relationship.
His argument is straightforward. The Fed has historically tightened rates and pulled back support whenever the economy showed signs of strength, under the assumption that excessive job creation or high wages would inevitably lead to inflation. This approach has failed time and again, yet the prevailing sentiment at the Fed seems resistant to change. Warsh doesn’t subscribe to that viewpoint; he believes that increased productivity and a broadened labor market can indeed coexist with price stability.
Meanwhile, as the Biden administration implemented stimulus efforts in an already recovering economy while inaccurately suggesting that Trump left a disaster behind, it seems the Fed has somewhat relinquished its independence, aligning instead with Biden’s strategies, which have contributed to the highest inflation levels seen in four decades.
In December 2021, Warsh made a compelling case in a Wall Street Journal piece, stating that if price stability erodes, financial stability is jeopardized. He warned about the “extraordinary excesses in monetary and fiscal policy” that could awaken inflation after years of relative calm. At that time, the Fed was still insisting that inflation was merely a “temporary” issue, and then-Chairman Jerome Powell faced pressure to resign.
Warsh’s foresight was evident. The subsequent rapid uptick in inflation led to the most aggressive Fed tightening seen in 40 years. Critics of the Fed argued that the decision-making moments were significant errors, while Warsh’s caution about prolonged easing appeared vindicated.
What’s often overlooked in the hawk-dove narrative is Warsh’s approach to analysis, which adapts to circumstances. John Orthers has pointed out that these categories are not rigid; economists can be both hawkish and dovish depending on the situation.
Warsh opposed a second round of quantitative easing in 2010 due to perceived increasing risks alongside diminishing returns. He also criticized the Fed’s extended easing into 2021, highlighting rising inflation. Now, with inflation receding and non-inflationary growth appearing again, he might advocate for rate cuts without straying from his principles.
The critical question here isn’t whether Warsh leans hawkish or dovish; it’s whether his analytical framework leads to sound decisions.
Tomorrow: Discussion on Warsh’s plans to reduce the Fed’s balance sheet and its implications for financial markets.
