Kevin Warsh must be in for a rude awakening

NEW YORK – Now that Kevin Warsh has been named chairman of the Federal Reserve, it’s worth asking how Warsh’s Fed will be different from the current one.

President Donald Trump has made clear he wants a Fed chairman who will push for lower interest rates to stimulate the economy and support his broader agenda. However, Warsh has a history of “hawkish” monetary policy (rigid stance against inflation)expressing concerns about the risk of excessive inflation even during the post-2008 deflationary cycle. Furthermore, he is a mainstream Republican globalist who favors free trade and immigration, not a protectionist-nativist Maga ideologue.

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So why did Trump choose him? In addition to the need to calm markets, which have been spooked by his attacks on the Fed’s independence, one reason may be that Warsh believes AI and other technological innovations will reduce inflation and thus allow for lower interest rates.

But there is a problem here: if AI reduces inflation, it will do so through higher GDP and productivity growth, which implies the need for a higher real (inflation-adjusted) interest rate and a higher long-term real interest rate, even if lower inflation implies a potentially lower nominal interest rate.

In short, AI would not necessarily justify a lower neutral federal funds rate. If Warsh and Trump’s other ally on the Fed board, Stephen Miran, think otherwise, they could be in for a nasty surprise.

A second possible reason is that Warsh expressed support for credit easing policies. But here too there may be a problem. With Michelle Bowman, another Trump appointee, now in charge of banking supervision, it is likely that Warsh’s Fed will accelerate efforts to ease credit conditions, even at the risk of fueling credit and asset bubbles.

And this, in turn, could compromise financial stability at a time when markets are already buoyant, leverage is high and private credit is unstable.

Warsh believes that reducing the Fed’s balance sheet will allow a sharper reduction in interest rates, based on the argument that quantitative tightening (QT) causes a tightening of financial conditions.

But he is simply wrong about this. Under the post-2008 regime, interest rates on excess reserves paid to banks offset the impact of these reserves on credit creation and financial conditions.

This is why the Fed was able to reduce its balance sheet by 25% without triggering tighter financial conditions. There is no reason to think that more QT justifies much lower interest rates.

Warsh’s opposition to the current large-reserve regime could backfire on him. After all, the recent aggressive QT policy has already put so much pressure on the repo and monetary markets that the Fed had to return to indirect quantitative easing (through the purchase of short-term bonds and reverse repos) last December.

If Warsh really wants to avoid further episodes of emergency quantitative easing, he should favor ample surplus reserves, not oppose them. If he can’t see it now, he will the next time financial stresses occur.

Furthermore, Warsh suggested that he may support a new agreement between the Fed and the Treasury, in which monetary policy would be further distanced from fiscal policy and public debt management. For example, this could mean reducing the Fed’s balance sheet and purchasing short-term government debt instead of long-term bonds – as was the case before the global financial crisis.

However, leaving aside the fact that it could also gradually eliminate the current regime of abundant reserves, further reducing the Fed’s holdings of long-term bonds would force the Treasury to redouble its policy of strategic issuance of Treasury bonds (ATI), which would imply even greater manipulation of the market for long-term debt and mortgage securities.

In fact, a new Fed-Treasury deal could lead to even more covert ATI and a greater mix of monetary and fiscal policy—exactly the opposite of the deal’s stated goal. Did Warsh or Treasury Secretary Scott Bessent take these risks into account?

Warsh also condemned the Fed’s “mission slippage” on issues such as financial stability, climate change and inequality.

But financial stability should undoubtedly be a goal of the Fed, especially if other Fed policies could lead to excessive credit easing.

Furthermore, as climate change may affect financial stability, due to large stocks of potentially distressed, impaired or stranded assets in real estate and other sectors, it would not be appropriate to simply ignore the issue.

And faced with a “K-shaped recovery” in which many families live paycheck to paycheck while a privileged few become richer than ever, ignoring inequality could end up being a mistake, especially if it is exacerbated by AI.

Fortunately, the Fed chairman is not an absolute monarch. Warsh will have just one vote out of 12 on the Federal Open Market Committee (Fomc). Although he is primus inter pares (first among equals), he cannot intimidate the committee into doing what he wants. This is good news for markets, considering how misguided some of Warsh’s stated positions are.

Furthermore, recent economic data suggests that US growth remains above potential – in fact, it may even accelerate this year, following a period of moderate slowdown last year – while inflation remains stubbornly above the Fed’s 2% target.

Therefore, even the single rate cut that the FOMC predicted for 2026 may not be justified. With other risks looming — such as a prolonged war with Iran, which is driving up oil prices and putting pressure on inflation and inflationary expectations — the Fed may well end up raising rates rather than cutting them.

Once confirmed, Warsh will soon have a reality check. The views he expressed as an expert are unlikely to survive an encounter with the real world of markets and geopolitics.

Translation by Fabrício Calado Moreira
Copyright: Project Syndicate, 2026