Fed Critic Kevin Warsh Calls for Fundamental Changes to US Central Bank's Operations

Kevin Warsh, a former Federal Reserve Governor who has been reportedly discussed as a potential replacement for Jerome Powell, delivered a scathing critique of the Fed and its operations. In a speech at a conference in Washington organized by the Group of Thirty, an international body of financiers and academics, Warsh argued that the Fed has overstepped its authority and compromised its independence. He emphasized the need for fundamental changes to how the central bank operates.

Warsh began his critique by arguing that the Fed's reliance on "stale" government data, subject to revision, is a major problem. He stated that this practice undermines the Fed's claims to operational independence and makes it difficult to accurately assess economic conditions. Warsh also criticized the Fed's use of forward-guidance, which he said has little role to play in normal times.

One of the main concerns raised by Warsh was the Fed's expansionary balance sheet policy, which he believes has contributed to the growth of the national debt. He argued that this policy is a departure from traditional central banking and has led to increased inflation after the COVID-19 pandemic. Warsh also criticized the Fed for making forays into areas outside monetary policy, such as regulatory policy and consumer protections.

Warsh emphasized that the Fed's actions in these areas have compromised its ability to ensure stable prices and full employment. He argued that each time the Fed jumps into action, it expands its size and scope, encroaching further on other macroeconomic domains. This, according to Warsh, has led to misallocation of capital, increased risk of future shocks, and compelled the Fed to act even more aggressively.

Market Reaction

Warsh's critique came at a time when the market was already under pressure from concerns about the US economy and the impact of Trump's trade policies. The president had been repeatedly criticizing Powell for not cutting interest rates since his inauguration in January. This escalating rhetoric, along with hints that Trump might try to remove him, triggered a selloff on financial markets.

However, it appears that Trump has backed off his aggressive stance against the Fed and China. He has stated that he has no intention of firing Powell and seems to have softened his tone on trade. The Wall Street Journal reported that Trump had privately discussed firing Powell with Warsh as recently as February, but advised him not to do so until Powell's term expires in May 2026.

Warsh's Background

Kevin Warsh was a Fed governor from February 2006 to April 2011, leaving about a year before Powell became a governor. During his tenure at the Fed, Warsh was frequently an advocate for tighter monetary policy and criticized the Fed's expansionary balance sheet policy. He argued that the Fed should not overstep its financial stability role to rescue banks and should not expect autonomy for other functions, including regulatory policy or consumer protections.

Warsh's views on monetary policy are closely aligned with those of some current hawkish-leaning central bankers. His speech was met with applause from this group, who celebrated his call for a return to traditional central banking practices. However, Warsh was not asked about reports that he is on the short list to be Trump's pick to replace Powell.

Implications and Next Steps

The implications of Warsh's critique are far-reaching, as they challenge the very foundation of the Fed's operations. His call for fundamental changes to how the central bank operates has sparked debate among economists and policymakers. The Treasury Secretary, Scott Bessent, has stated that the administration will start interviewing candidates for the top Fed job in the fall.

It remains to be seen whether Warsh's views will have any impact on the selection of Powell's successor or the overall direction of monetary policy. However, one thing is clear: Kevin Warsh's critique of the Fed has raised important questions about the central bank's role and its relationship with the government.