Way Out West with Kevin Warsh
Analysts closely monitoring the Federal Reserve have already speculated on Kevin Warsh’s upcoming presentation at Jackson Hole. They’re eager for the new Fed chairman to clarify whether inflation is driven by fleeting disturbances or if it indicates an overheated economy, along with his insights on potential interest rate changes.
However, it seems Warsh may have a different agenda in mind.
During his press conference in July, he mentioned that he intends to use the Jackson Hole forum to “frame the big questions.” He pinpointed three key topics: productivity trends, demographic shifts, and the impacts of ongoing global economic challenges.
This approach suggests he’s preparing a speech centered on the mechanics of the economy rather than just a preview for the forthcoming Fed meeting. It also aligns with concepts Warsh has been refining for quite some time.
He is particularly concerned that the Fed’s current framework may focus too heavily on aggregate demand, while neglecting the economy’s productive capacity. In his July remarks, he indicated that while the Fed has a solid grasp on demand, it must make assumptions about supply and productivity. He depicted the current economic situation as a “race between supply and demand.”
Jackson Hole offers Warsh a distinct chance to present his overarching perspectives on the economy. He likely won’t miss this opportunity to resist the pressure to include forward guidance, which he believes should be phased out. He may see this speech as a way to demonstrate his independence not only from political influence but also from the expectations of analysts and commentators.
The AI Boom: Inflation First, Productivity Later?
The rise of artificial intelligence complicates the balance between supply and demand. Investments in data centers, power plants, and semiconductor manufacturing are driving current spending and elevating prices for chips, energy, equipment, and specialized labor. These are immediate demand-side impacts. Yet, the productivity benefits of this investment will come later, and the timeline remains uncertain.
So far, many businesses have found that the anticipated quick productivity improvements have not materialized. In fact, the reality often seems to be quite the opposite, with the learning curve associated with AI potentially slowing productivity in the short term.
Warsh has identified AI as arguably the most significant technological advancement of his lifetime. He expects it will enhance the U.S. economy’s wealth and productivity. However, he’s also noted that AI might disrupt job markets and that the current surge in investment might outpace the economy’s ability to respond.
A speech at Jackson Hole could detail how AI might drive up investment, specific prices, and real interest rates before ultimately lowering overall costs in the economy. He could articulate how these dynamics influence Fed policies.
Demographics also play a crucial role in the productivity discussion. Economic expansion fundamentally relies on increases in both output per worker and the number of workers. With immigration levels plummeting and the population aging, workforce growth has slowed considerably. Consequently, fewer new jobs are needed to maintain steady unemployment rates.
This scenario helps clarify the seemingly paradoxical situation of weak payroll growth, low unemployment, and robust business investment. Companies can’t significantly increase payrolls if the number of employees is stagnant. This means they will likely compete more for available workers, even in a low-growth job market, and seek ways to enhance output per worker instead of simply boosting payrolls. It also suggests that the Fed might need to reconsider interpreting apparently disappointing job reports as automatic indicators of recession or an urgent need for easier monetary policy.
Warsh’s differentiation between inflation and relative-price modifications naturally fits within this framework. He’s likened wars, tariffs, energy crises, and supply-chain disruptions to weather. They may affect specific prices and impose tangible costs on households. In contrast, inflation resembles climate: a persistent, widespread rise in prices that influences expectations and economic choices.
Connecting the Dots
The Fed’s challenge lies in assessing whether the increases in oil prices, imported goods, or AI infrastructure remain narrowly focused or have a broader economic impact. The goal is to determine if these factors create enduring price pressures or if they’re likely to dissipate. Warsh maintains that the central bank must be accountable for inflation over time. Temporary shocks shouldn’t serve as a blanket excuse for missing the two percent inflation target. Additionally, raising rates in response to high headline inflation may not yield long-term benefits, especially if increased borrowing costs hinder the growth of the supply side.
The forthcoming speech might also link these economic shifts to Warsh’s institutional reforms. His five task forces are examining Fed communications, its balance sheet, economic data, productivity and employment, and inflation frameworks. These topics closely align with the questions posed by an economy reshaped by AI, a declining labor pool, and a more dispersed global trading landscape.
Warsh is expected to refrain from announcing or even hinting at what the Fed plans for September while still providing valuable insights into his economic perspective. He can clarify which questions the Fed intends to explore: whether growth stems from demand or expanding supply, the broadness of price increases, whether weak employment is due to diminishing labor demand or slower workforce growth, and whether financial markets are indicating inflation or stronger anticipated returns on capital.
This, I think, encapsulates what Warsh feels needs to be achieved at Jackson Hole. While the economics community may be eager for forecasts, Warsh seems poised to offer a more comprehensive framework instead.
