Recent reports suggest that the contest for the next chair of the Federal Reserve is down to Jay Powell, a current member of the Federal Reserve board, and Kevin Warsh, a member of the board from 2006 to 2011. And the rumor mill suggests that it is Warsh—a former Wall Street denizen whose father-in-law Ronald Lauder is a good friend of Donald Trump—who is the odds-on favorite.
Such a possibility is deeply unsettling: Selecting Warsh as chairman of the Federal Reserve Board could prove to be disastrous both to the economy as well as Trump’s chances for re-election. Put simply, Warsh has demonstrated a fundamental inability (or unwillingness) to understand precisely how monetary policy works in today’s economy, and that the rules we used in the past to gauge inflationary pressures simply do not work like they once did. Having him direct monetary policy would increase the risk and prolong the length of a future recession.
Putting a Lawyer in Charge is Never a Good Idea
One knock against Warsh is his lack of a Ph.D. in economics, which these days has become de rigueur for the position. While his carefully curated Wikipedia page reports that he took advanced classes on financial markets, he studied law at Harvard—where the curriculum has nothing to do with the macroeconomy.
President Trump has indicated that he’d rather have someone other than an economist running the Fed, and there should never be some sort of degree requirement for that—or any other—position. However, the idea that a Ph.D. in economics is superfluous to being Fed chair is slightly ludicrous: It’s not as bad as suggesting that people without medical training should licensed as brain surgeons but it’s up there. Warsh is keenly aware of this problem and he has railed against the “guild” of economists monopolizing high-level positions at the central bank.
As someone who has a Ph.D. in economics, I will testify that a good deal of what graduate programs in economics impart on their students is worthless, and I grant the profession knows painfully little about how the macroeconomy actually works, which the last recession revealed.
But the Ph.D. in economics teaches a student how to think cogently about economic matters, and it provides the skills and background necessary for someone to interpret data and understand the arguments that economists (and others) make with data in a way that cannot be taught elsewhere. “Thinking like an economist” is a pejorative in my household and many others, but such a perspective turns out to be useful when—for instance—it is necessary to contemplate the efficacy of Fed actions.
And to execute the job of Federal Reserve chairman requires a special kind of intellect: the last four chairs—Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen—spent decades of their lives studying monetary policy and macroeconomics. Each of them was considered a leading macroeconomic expert in the profession at the time of their appointment. To appoint a non-economist to chair the fed is akin to picking an economist to sit on the Supreme Court.
Warsh’s supporters would no doubt say that such a comparison is unfair, given his previous stint on the Fed Board. But the flaw in that argument was that he was unqualified for that position as well, and he did nothing to redeem himself while on the board. The ostensible argument for that appointment at the time was that he could serve as the eyes and ears for Ben Bernanke on Wall Street—not a useless skill for the Fed to have, to be sure, but probably not terribly essential, either, given that Bernanke—or any Fed chair—can talk to literally anyone on Wall Street by simply picking up a phone.
And it’s not as if Warsh was a master of the universe during his time on Wall Street: Six years doing mergers and acquisition work as an associate for Morgan Stanley isn’t the same as running Goldman Sachs. And working for the National Economic Council may sound glamorous, the reality is quite different and no one there is thinking about monetary policy on a daily basis.
The Many Mistakes of Kevin Warsh
By all accounts Kevin Warsh is a nice guy, and he has certainly shown himself to be a savvy political operator: to parlay a grunt job on Wall Street and a low-level administration job into a position on the board of governors of the Federal Reserve Bank demonstrates an amazing amount of moxie. The steps he’s taken to make himself a top candidate for chair of the Federal Reserve since he left the board have also been brilliantly orchestrated.
However, political savvy has nothing to do with the job of running monetary policy for the United States. It is a job for a serious person who has spent a lifetime thinking about monetary policy. That is simply not who Kevin Warsh is—or ever could be—and his actions and comments while he served as a member of the Federal Reserve Board reveal him to be someone who doesn’t really understand monetary policy.
For instance, during the dark days of 2008, when the stock market was in a free fall and there was a genuine fear that global financial markets might completely melt down, Warsh continued to express his fears of inflation, and counseled Ben Bernanke to be cautious lest we experience a rise in the CPI a couple years down the road. It was an insane perspective and one that—had Bernanke ignored his instincts and heeded it—might have proved disastrous. Bernanke also implies in his book, The Courage to Act, that Warsh was part of the group that refused to go along with a reduction in the interest rate after the Lehman collapse that spring, despite him telling the other members that it was almost certain that the economy was already in a recession.
In 2010, in his waning days on the board, Warsh remained preoccupied with the specter of inflation despite the complete lack of evidence suggesting its incipient appearance. In an FOMC meeting late that year he argued that the Fed should consider pulling back on its quantitative easing despite the fragile nature of the economy, reasoning that if it were to do so it would prompt Congress and the White House to act with another round of expansionary fiscal policy.
Suggesting that the Fed play political chicken with Congress is, in a word, insane. The Federal Reserve has a legislative mandate to pursue both full employment and price stability in monetary policy. What Warsh suggested would have effectively set that aside and inserted the Fed into the middle of a highly charged political battle that could have harmed the economy. People who allege that Warsh’s appointment would make the Fed more political can point to this as Exhibit A.
To be fair, there were other people who worried that the Fed’s actions during that time might lead to future inflationary pressures, but those people didn’t work in the Federal Reserve and have access to the latest research and some of the most capable monetary economists in the country, and none of them are currently candidates to be chair of the Fed.
Warsh’s comments since leaving the Fed have also been hawkish, albeit sufficiently vague as to give him a modicum of wiggle room when testifying.
What We Pay a Fed Chair to do
Being the chairman of the Federal Reserve involves much more than just deciding on whether to move interest rates seven times a year. It requires the courage—and intellect—to question the consensus about the economy on occasion.
For instance, 25 years ago, Alan Greenspan—at the time chairman of the Federal Reserve—defied convention when he declared he was unconvinced that the moderate economic growth rate at the time was inflationary, and he refused to have the Fed reflexively raise interest rates to tamp down “excessive growth” so as to arrest any incipient inflation.
Greenspan may have made his share of mistakes in his tenure as Fed chair, but this proved to be a master stroke. Following his intuition and the data, which told him that the U.S. economy was on a cusp of a productivity boom, he convinced the board to stand pat on interest rates when growth got above 3 percent. Their decision allowed the U.S. economy to enjoy its most robust period of economic growth since World War II. Not only were growth rates high—averaging a whopping 4 percent from 1996-2000, almost unheard of for the tail end of an economic expansion for a developed economy—but those gains were widespread as well: The income gains of the lowest quintile actually exceeded those of the rest of the workforce over that period, as the low unemployment rates forced companies to raise wages and invest in their low-skilled workers in order to retain them.
Paul Volcker, who became chair in 1979, convinced the rest of the board to rein in the money supply and kill inflation, a step for which he received a lot of political blowback. While it precipitated a nasty recession, wringing inflationary expectations out of the economy laid the groundwork for a quarter-century of solid economic growth.
Ben Bernanke bucked the advice of his colleagues—Warsh included—in his efforts to use monetary policy to stimulate the economy during the fiscal crisis of 2008, and he kept his foot on the monetary policy gas until he left the position.
Janet Yellen observed the lack of inflationary pressures and continued Bernanke’s expansionary monetary policy longer anyone ever thought it would go, going against the advice of her senior staff and their models. That turned out to be the right decision: Today, inflation remains low and the economy is in its ninth year of an economic expansion.
It is hard to see Kevin Warsh having the ability and gravitas to lead the board in such a way, and we probably wouldn’t want him to: His vague promises to fix the central bank—which would presumably involve less discretion by the Fed and more cooperation with Congress and the White House—aren’t particularly good ideas to begin with.
Politicizing the Fed May not Help Donald Trump
At this moment the Phillips Curve—which says that lower unemployment begets higher inflation—has been the guiding precept for monetary policy orthodoxy for 50 years. The problem is that it is completely broken and has been for some time. The country needs a central bank chair that recognizes this reality and is adept enough to construct a coherent approach to monetary policy that doesn’t depend on this shibboleth. That is most emphatically not Kevin Warsh.
What’s more, the relationship between the money supply and the rate of inflation has radically changed as well. While Milton Friedman’s dictum that inflation is always and everywhere a monetary phenomenon still holds, the Federal Reserve’s almost unprecedented accommodative monetary stance has produced very little inflation, and most economists I know who follow the central bank’s goings ons these days are more concerned about deflation than inflation.
It’s easy to see why Trump might want Warsh: He is clearly amenable to playing politics with the Fed and the president appears to think that he can be counted on to do whatever it takes to goose the economy if need be should the economy stall prior to Trump’s 2020 re-election campaign.
However, it’s very possible that Warsh himself, given his preoccupation with non-existent inflation and his vague pledges to radically reform the Fed, precipitates a recession himself through his bungling. What’s more, it’s not as if any other Fed chair would sit idly by should the economy sputter: nearly everyone else being considered could be counted on to use monetary policy aggressively to give the economy a boost during a downturn, regardless of the occupant of the oval office.
And regardless of what causes it, the next Fed chair would go into a recession with many fewer bullets in the holster, given that the current interest rate is just 1.25 percent. The average Fed response in the last three recessions has been a four percentage point reduction in interest rates, a response that is arithmetically impossible unless the central bank were to start imposing negative interest rates—an unprecedented step in the U.S., although one that’s been done elsewhere.
What’s more, in its last meeting the Fed also announced its intent to begin slowly selling off the four trillion dollars of assets on its balance sheet, most of which it bought in the wake of the financial crisis. How aggressive would Warsh be in re-instituting quantitative easing, or pursuing other steps to provide fiscal stimulus to the economy? Or will he let Congress do the heavy lifting instead?
Maybe any fool can run the fed when the economy is going well, but this is a special time in the U.S. economy and we need someone in charge who actually knows a thing or two about monetary policy. What Kevin Warsh has apparently learned about the subject is dangerous.
