Newly installed Federal Reserve Chair Kevin Warsh is experiencing a bout of policy reality. If you preserve the status quo, you’ll be attacked. If you challenge the status quo, you’ll be attacked even more.
Warsh knew this going in. He is upending the status quo.
The headline grabber is the five task forces he’s established to review how the Fed does its job. These task forces, expected to report sometime in 2027, will examine such matters as balance sheet policy, understanding inflation, and communications.
The focus on balance sheet policy and inflation is particularly welcome. Warsh has rightly indicated a strong desire to shrink the Fed’s balance sheet substantially. It exploded with the 2008 financial crisis and again during the pandemic as quantitative easing came to the fore.
Rapidly shrinking the balance sheet will inter alia recenter monetary policy on interest rates while eliminating the suggestion that, in purchasing and holding Treasury notes and bonds beyond a necessary minimum, the Fed violates the great taboo of monetizing fiscal policy.
The emphasis on rethinking inflation is likewise welcome. Low inflation is essential to prosperity.
Warsh has been very clear about sticking to a firm 2% inflation target. Yet the Fed staff’s economic models, developed over many years and sustained by copious amounts of group think, consistently perform poorly in forecasting inflation.
One reason for such consistent failure, one suspects, is a slavish and unfortunate adherence to the belief that a strong economy induces higher inflation, a silly notion captured in what’s called the “Phillips Curve.” Regardless of how often the Phillips Curve misleads, much of the economic profession continues to kowtow at the Phillips altar.
Warsh instituted a more immediate change by abandoning “forward guidance,” which just means providing a framework for how the Fed might act in the future. If the data does this, then we’ll do this. But if the data comes in very differently, then we’ll do that.
Forward guidance was originally intended to buttress the influence of the Fed’s actions on market behavior. It largely failed because current realities often diverge in unexpected ways from past forward guidance.
Forward guidance also helps financial markets discern the Chairman’s “reaction function.” This was but an intellectual crutch for lazy sods who are none too happy Warsh makes them trod along on their own. Better analysts understand they make their money by correctly piercing through uncertainty. These analysts never needed the crutch.
Congress should also get in on the Fed reform act. It’s a target-rich environment. One target often ignored is the Federal Open Market Committee (FOMC). While the Federal Reserve Board runs everything else the Fed does, the FOMC sets policy interest rates, most notably, the Federal Funds rate.
It is axiomatic Federal policy should be made by elected officials or duly appointed representatives thereof. The FOMC is comprised of seven presidentially appointed and congressionally confirmed Board members, plus five more luminaries.
The New York Fed President is also an FOMC permanent member. Surely such a critical policy-making position requires a presidential nomination and congressional confirmation. Wrong.
The NY Fed President is chosen by its Board of seven corporate CEOs, the President of the Rockefeller Foundation, and the Director of Education and Training for the union representing theatrical stage employees. All policy involves politics and all politics involves theater, but does working for a union representing stage workers qualify one for judging monetary policy acumen?
The rest of the FOMC membership falls to four of the other 11 regional Fed presidents on a rotating basis, all likewise chosen by CEOs and other curiosities. None are nominated by the president. None are confirmed by the Senate. Yet all have tremendous influence on monetary policy and therefore on inflation and unemployment.
Regional presidents should go through the same nomination and confirmation process as Fed Board members, each with fixed, four-year terms. As democratically elected representatives, the president and the Congress will be held responsible for the consequences of FOMC actions. Elected officials should determine who takes those actions.
Another reform would clarify that when a Chairman’s term expires, they turn in all their office keys. A Chairman is confirmed as a Board member and, separately, as the Chair. This is how former Chairman Jay Powell lingers on the Fed’s Board.
Previously, when a Chairman stepped down, they had the good form to leave the building altogether. In one last demonstration of bad judgment, Powell chose to hang around, hovering like a specter over Chairman Warsh’s shoulder. As Chair, Jay Powell was always “too late.” Now he’s too late in departing the Board. At least he’s consistent.
J.D. Foster is the former chief economist at the Office of Management and Budget and former chief economist and senior vice president at the U.S. Chamber of Commerce. He now resides in relative freedom in the hills of Idaho.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of the Daily Caller News Foundation.
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