An optimistic outlook for Kevin Warsh at the Federal Reserve

Kevin Warsh will soon be welcomed into the US Federal Reserve as its next chair. This became apparent when the Trump administration backed away from its criminal investigation into current chair Jay Powell and Senator Thom Tillis said on Sunday that this action was sufficient for him to vote in favour of Warsh.

The US Senate will probably vote rapidly to confirm Warsh after a favourable report from its banking committee this week. Powell will stand down as chair on May 15. He will also have to make a decision on whether to resign as a Fed governor before his term ends in January 2028. My bet is he will stay on for now.

Lots of fine economists think Warsh will be a terrible Fed chair because, as Paul Krugman put it, he was “afraid to even show a little bit of verbal independence” from President Donald Trump at the hearing last week. My impression was we learnt a lot about what Warsh had to say to get the nomination, including being evasive about who won the 2020 US presidential election, but not much about how he will lead the central bank.

For me, that was a reassuring outcome. There was a lot of talk from Warsh about “regime change” and the terrible mistakes the Fed has made, but very little about big changes to come. In fact, much of the substance in the testimony was just a different way of expressing current Fed policy.

Getting answers to the questions I posed last week was difficult, especially as senators, both Democrat and Republican, preferred to grandstand. But here are the moments in the hearing that I think best addressed the questions (with time stamps).

• Will Warsh be Trump’s lackey? The committee preferred the term “sock puppet”, a suggestion Warsh rejected (1 hour, 16 mins). However, Warsh disagreed publicly with the president only on the most trivial items, such as whether he was from central casting as a central banker (47 mins), leaving this question unanswered.

• Does an energy shock require tighter monetary policy? Warsh was hardly questioned on this, but suggested the Fed should only seek to affect things “that are not one-off in nature, but are persistent and find their way into the generalised price level”. This is clearly a change from his stance in 2011, but a reasonable and pretty normal approach for a central banker. It is also the Fed’s current position, so not regime change.

• Where should US interest rates go? Warsh did not say they should fall. Instead he said the “Fed’s going to have to dig deep in evaluating what’s the right policy choice in the upcoming meetings” (1 hour, 12 mins). Warsh did say he thought AI would increase supply more than demand, which implied interest rate cuts, but added that “considerable work” needed to be done to make an informed judgment. His view was clear, but nothing sounded urgent (2 hours, 21 mins). Warsh insisted interest rates should be the primary tool of monetary policy (1 hour, 40 mins), which happens to be exactly the same view as the Fed.

• What is Warsh’s theory of inflation? Warsh said “inflation is the Fed’s choice”, coming about when the central bank prints too much and the government spends too much (2 hours, 2 mins). This was entirely consistent with his past statements. He did not explain how the unsustainably large and growing US deficit affected inflationary prospects.

• What does Warsh really think about the Fed’s balance sheet? Warsh thinks the balance sheet’s past growth was a disgrace and forced interest rates higher (1 hour, 48 mins), but that it cannot be shrunk quickly. Any reduction would have to be “deliberate, well-orchestrated, well-choreographed and well-described so that unnecessary upset [is] not done to financial markets”. (2 hours). This sounded to me like evolution, not revolution.

• Will Warsh seek deference from other Fed officials? It seems not. He said he wanted “clean memos and messier meetings. And there’s nothing wrong with a divergence of opinion.” This is a change from his own stance when he was a Fed governor, but a welcome one.

• Warsh and the relationship between the Fed and US Treasury. Warsh largely stuck to his previous views, saying the Fed is “independent inside of government, not independent of government” (2 hours, 16 mins), and that it would “stay in its lane” with him as chair (35 mins). He would work with the administration on “non-monetary matters that are part of the Fed’s remit” (35 mins).

• Warsh on financial regulation, crypto and stablecoins. Warsh was clear that the Fed’s approach to financial regulation should not be seen as independent of government, which is no change from today. He said digital assets were already an integral part of US financial services (1 hour, 44 mins).

• Warsh on communications. Warsh committed to new communications with less forward guidance. (41 mins). The dot plots look as if their days are numbered.

• Warsh’s attitude to theory, conviction and data. Warsh’s main contribution here was a commitment to undertake a major data project on inflation measurement. He said he preferred “trimmed-mean” measures of inflation and medians, suggesting these were new ideas. They are not. A problem here is while his favoured trimmed-mean PCE measure of underlying inflation gives the most comforting reading for US inflation now, it also did in 2021 and 2022 when he said the Fed was making its worst mistake in 40 or 50 years. (1 hour, 23 mins). See the chart below or this excellent piece by Joel Suss on Monetary Policy Radar, which also explains why our FT core measure is superior.

Bother at the BoE

In recent weeks I have heard lots of reports of unhappiness at the Bank of England. Some 446 are staff leaving on a mutually agreed resignation scheme with over 700 wanting to quit. There is little doubt a lot of people feel unsettled. Anything more is gossip, which this newsletter avoids.

The BoE faces a difficult task this week in making its new economic projections coherent. A foundation for any economic forecast is its conditioning assumptions, and here the BoE has a problem. Energy futures prices are inconsistent with interest rate futures, and both form the basis of the BoE’s inflation projections.

Energy futures, whether oil or natural gas, are relatively sanguine about the Iran war. They imply prices will fall pretty quickly from around $100 per barrel in April to $78 by the end of 2026 and $74 by the end of 2027, suggesting a relatively short energy shock. (These prices have been taken in the normal window the BoE uses before its inflation projections.)

Mechanically, if these prices are realised they would increase inflation in 2026. But with oil prices then falling, energy would be reducing inflation from mid-2027 onward. This would be the classic supply shock that central bankers prefer to “look through”.

The problem the BoE has is that the forecast is normally also conditioned on interest rate expectations, which are persistently higher and inconsistent with the “look through” approach. The upshot would be a central forecast with obviously too tight monetary policy and persistently below-target inflation, including possibly a period of deflation.

So what can the BoE do when financial markets are telling inconsistent stories?

Plough on as usual

The BoE could pretend nothing was up, sending a not-so-subtle message to financial markets that they were pricing interest rate risk wrongly. It would also have to disown its central forecast, which would be ugly for growth and a communications nightmare.

A variation of this option would be to tweak the model sufficiently to have inflation broadly on target by the end of the forecasting horizon. This is not much better because it suggests the BoE thinks its credibility is so feeble that a minor energy shock requires it to have persistently higher interest rates.

The ECB option

The second option would be to copy the European Central Bank’s rather successful scenarios and communication from March. This approach would take a number of different energy price scenarios, including in the upper tail of the distribution, and produce forecasts using the same interest rate conditioning assumption, recognising that this assumption would not hold in practice.

This would allow the BoE to ditch an internally inconsistent central forecast and prompt it to consider what energy price scenario fits best with the assumption of interest rates rising from 3.75 per cent to a bit over 4 per cent and staying there. These scenarios would be more coherent, although the interest rate assumption would be too hawkish in moderate energy scenarios and too dovish in really severe shocks.

Ditching futures markets

The BoE does not need to use futures market pricing as a conditioning assumption. It could ditch its central forecast and the future interest rate path to just present scenarios of energy prices along with simple monetary policy rules for interest rates. These projections would immediately be broadly internally consistent and show roughly what the BoE thinks would happen to monetary policy under different energy price scenarios.

This has already been the direction of travel for the BoE. At a moment of genuine uncertainty over energy prices, now would be a great moment to do scenarios properly. Will the central bank do it? We will find out on Thursday.

What I’ve been reading and watching

• Check out the FT’s new Story of Money YouTube channel.

• At MPR, we updated our interest rate scenarios for the Fed, ECB, BoE and Bank of Japan, adding a low-probability high-impact scenario of fuel shortages.

• If you want to check the lie of the land on tariffs, go to our tracker page.

One last chart

Sticking with the UK, the BoE’s April decision-maker panel survey, which was a good predictor of services inflation between 2021 and 2025, showed companies expecting to increase prices sharply over the year ahead. The worry is that this shows companies have pricing power and intend to use it. Two more reassuring results of the same survey were that wage expectations were muted and companies expect to share the pain of higher energy prices in lower profit margins.

Central Banks is edited by Harvey Nriapia