BREAKINGVIEWS-Trump Fed favorite has policies for different era

By Gabriel Rubin

WASHINGTON, April 30 (Reuters Breakingviews) - The U.S. Federal Reserve has become an immensely powerful institution. Kevin Warsh, President Donald Trump’s favorite to succeed Jerome Powell as the central bank’s next chair, is eager to roll some of that power back. He used a speech at the International Monetary Fund last week to criticize the Fed’s inflation-fighting record and its overreach in issues such as diversity and climate change, arguing that these failings had undermined its credibility and independence. The problem is that changing this is both practically difficult and politically ill-advised.

Warsh is no stranger to the central bank. The former investment banker served as a Fed governor from 2006 to 2011, helping to shape its response to the 2008 financial crisis before resigning in protest at its continued bond-buying policies. He was short-listed to become chair during Trump’s first term but lost out to Powell. More recently the president has consulted Warsh on Fed policy, including whether to fire Powell, the Wall Street Journal reported, citing people familiar with the matter.

Warsh’s critique divides roughly into three parts. First, he argues that the central bank's obsession with short-term data and its focus on boosting employment led it to bungle the post-Covid inflation outbreak.

Second, the Fed’s failure to unwind crisis-era bond-buying has blurred the lines between the central bank and the federal government. Prior to 2008 it held under $800 billion in Treasuries and no mortgage-backed securities. Now, even after some recent runoff, the Fed’s balance sheet is $6.7 trillion. Warsh correctly says that subsidizes politicians’ profligacy: “it’s no longer obvious whether monetary policy is downstream or upstream from fiscal policy,” he lamented.

Third, the Fed has defended its autonomy in financial regulation, policy areas where Warsh says there should be no expectation of independence from political oversight.

Though Warsh’s criticisms have merit, his timing could not be worse. The bond market is under significant stress and revolting against Trump’s policies. Signalling a desire to withdraw from markets would risk further turmoil. Similarly, it’s a bad moment to welcome greater political oversight on aspects of Fed policy. The White House is actively engaged in weakening the autonomy of every independent agency in the federal government: in February, Trump signed an executive order, possibly illegal, that put agencies including the Securities and Exchange Commission under the control of the White House. The only explicitly exempted authority in the order was the Fed’s monetary policymaking.

Warsh is right that the Fed’s continued autonomy depends on its ability to control inflation. But any move to shrink its responsibilities should be seen as risky. The bond market swoon that followed Trump’s recent threats to fire Powell shows the Fed’s independence is a red line. After initially backing off, Trump renewed his criticism of Powell at a rally on Tuesday, suggesting there could be more ructions to come. The world has changed since Warsh left the Fed in 2011. His policy prescriptions appear designed for a different era.

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CONTEXT NEWS

Former Federal Reserve Governor Kevin Warsh delivered a speech in Washington on April 25 during which he criticized the central bank and called for fundamental changes to its operations.

President Donald Trump has mulled firing current Fed Chairman Jerome Powell and installing Warsh in his place, the Wall Street Journal reported on April 17, citing people familiar with the matter.

Speaking at a conference organized by the Group of Thirty, an international body of financiers and academics, Warsh said he believed in the Fed's "operational independence" but argued it had gone beyond its remit and undermined its claims to independence.