How the Federal Reserve might change under Kevin Warsh

0:02Claire Jones: Late last week, U.S. President Donald Trump announced his pick for the next chair of the Federal Reserve. That person is Kevin Warsh. Warsh throughout his career has straddled both Wall Street and policy circles, and at one time was a member of the Fed Board of Governors. But he's also challenged the way the central bank is being run under current chair Jerome Powell, whose term ends in May.

0:28Kevin Warsh: Walsh may have risen to prominence as a Fed governor, but since he left the U.S. Central Bank, he's emerged as a major critic. Now that he's about to succeed Powell in the top role, we have quite a lot of questions about how he intends to do the job differently.

0:49Claire Jones: If Walsh is confirmed by the Senate, what will that mean for the future of the Fed and U.S. monetary policy? The FT's U.S. economics editor, Claire Jones, has been following this selection process closely. I'm going to talk with her about all of that on today's show. I'm Michaela Tendera, and this is Behind the Money.

1:19Hi, Claire.

1:20Claire Jones: Welcome to the show. Hi, Michaela. Pleasure to be here. Yeah, so glad to have you. Claire, tracking this process for the FT and waiting to see who President Trump is going to select over the past several months, what's that all been like?

1:34Kevin Warsh: Well, Trump has spent the majority of his second term really having a bash at the U.S. Central Bank. The U.S. president has wanted interest rates to really be a lot lower than they are at the moment. He's said they ought to be at 1%. What that's resulted in is that the current chair, Jerome Powell, has faced some really ferocious barbs from the U.S. president. And that's led to the sense that there's been a cloud hanging over this whole appointments process as to what the next pick to chair the Fed is going to mean for the central bank's independence. So it was quite relieving that we saw Trump on Friday pick Kevin Walsh, who in many senses is a rather orthodox candidate for the job.

2:17Claire Jones: Yeah. Tell me a little bit about Kevin Walsh. You say he's a quite orthodox pick. He's also served as a special assistant for economic policy back in George W. Bush's administration. But what else do you know about his background?

2:31Kevin Warsh: As you say, he's worked for George W. Bush. He's very well connected in political circles and in policymaking circles here in D.C. and beyond. He's also very well connected in financial markets. Kevin Walsh rose to prominence when he joined the Fed in 2006 when Ben Bernanke was chair. and he worked very, very closely with Bernanke and other top officials during the global financial crisis of 2008. During that crisis, Walsh is seen as having played a vital role in serving as a conduit between investors on Wall Street and the brains of senior Fed officials such as Ben Bernanke, who played a role of devising the policies that helped keep the U.S.

3:19Kevin Warsh: economy and U.S. financial markets on track during some of the worst turmoil that we'd seen since the Great Depression. So overall, he made a very good impression during his time at the Fed. And in that sense, looks like quite a strong candidate to be the central bank chair.

3:38Claire Jones: Now, earlier last year, it seemed like Kevin Warsh was going to be the most likely pick to be the next Fed chair. But then there were some doubts that cropped up and the pendulum swung toward another candidate, Kevin Hassett. So why did Trump eventually end up going with Warsh?

3:59Kevin Warsh: I think it's a very interesting question. For a long time, the sense was that Trump would pick a close ally for the job. While he does know Warsh very well, the candidate who was closest to Trump was Kevin Hassett, who's currently the director of the National Economic Council at the White House. However, I think two factors led to Hassett falling out of the race and it really opening up for Walsh. One was that investors on Wall Street weren't that keen on Hassett. They saw him as being too close to President Trump. And given how aggressive Trump has been in terms of trumpeting an agenda of ultra low interest rates, there were concerns that Hassett would damage the Fed's independence.

4:51Kevin Warsh: However, what really killed Hassett's chances was when it emerged that the Department of Justice was conducting a probe into Jay Powell. What we saw then was a real backlash, including from Republican senators, against Trump's attempts to undermine the Fed's independence. And there was the sense then that Hassett just wouldn't make it through a Senate confirmation process. After that occurred, Trump suggested he wanted to keep Hassett close to him in the White House. And then you really got the sense that Walsh's chances had risen quite substantially.

5:30Claire Jones: So how are investors receiving the news of Walsh's appointment?

5:34Kevin Warsh: What we've seen so far from the investor reaction is, I think, an element of relief. There were real concerns that Trump would choose someone who would really threaten the independence of the Fed by going in there and just doing the White House's bidding and trying to force through interest rate cuts, which other committee members might not have agreed with, and, you know, leading to a really dysfunctional central bank. I think with Walsh, the feeling is that he is a relatively mainstream pick. He had the experience with the Fed during the financial crisis. He's a known quantity in some respect.

6:17Kevin Warsh: I think markets are still trying to work out exactly how we do the job. But I think they are relieved that Trump's gone for someone who is relatively mainstream.

6:26Claire Jones: Now, as you said, Claire Warsh was pretty instrumental in the Fed's 2008 crisis response. But since he left his position of Fed governor in 2011, he's been critical of the central bank. Why is that?

6:40Kevin Warsh: So this isn't the first time that Kevin Warsh has run for the job of Fed chair. He interviewed for the role back in 2017, but missed out and it went to Powell instead. Now, since then, he's spent an awful lot of time attacking the Fed very vocally and with some strength and in the view of a lot of people within the Fed today, rather unfairly too. In my view, as we think back of the most recent period of years, forays far afield, for all seasons and all reasons and with the best of intentions, have led to systematic errors in the conduct of macroeconomic policy.

7:27Claire Jones: The Fed has acted more as a general purpose agency of our government than a narrow central bank that preceded my days as a central banker.

7:37Kevin Warsh: A lot of the criticisms that Walsh has made has focused on the Fed's balance sheet. Since the global financial crisis, the Fed's been buying a lot of mostly government bonds, and that's meant the balance sheet has expanded from under a trillion dollars to, at its peak, somewhere close to nine trillion dollars, which is quite a rapid expansion.

8:01Claire Jones: Well, yeah, let's unpack that a bit. When we're talking about the balance sheet here, That's what the Federal Reserve owns. So it's assets and liabilities.

8:11Kevin Warsh: Yeah, that's correct. And the main asset that central banks hold is government bonds. Now, prior to the global financial crisis, central banks' balance sheets didn't play that important a role. However, during the financial crisis and then in the decades that followed, balance sheets have become an enormous part of what central bankers refer to as their monetary policy toolkit. What we've seen emerge is mass government bond buying by the Fed, a process known as quantitative easing, which other central banks have followed too. The aim of this policy originally was to keep the financial system secure.

8:56Kevin Warsh: It's also being seen as something which can help keep inflation and economic growth reasonably stable too. However, what the popularity of using the balance sheet has meant is that balance sheets have, according to Walsh, become bloated. The balance sheet now is back down to about$6.6 trillion, but it's still a lot larger than it was. And the sense that we've got from Walsh is that he really wants to spend a lot of his time as Fed chair making the balance sheet smaller and getting it back closer to that pre-2008 global financial crisis size.

9:36Claire Jones: So the Fed spent many years buying up bonds, aka pursuing quantitative easing after the financial crisis. Um, why does Walsh think that that's a problem?

9:47Kevin Warsh: I think Walsh really sees the Fed as having strayed past its proper mandate in the years following the global financial crisis. But the Fed used the balance sheet to buy U.S. government bonds, which enabled governments to take actions which led to bigger deficits, which led to governments into spending more than they would have otherwise done. He thinks that all the U.S. government bond buy-in has let Congress off the hook. It's stopped politicians being under pressure to manage spending. He sees it as the central bank has strayed beyond monetary policy into territory that's seen more as the domain of politicians, that's seen as more like fiscal policy, if you like.

10:35Claire Jones: Now, this isn't exactly a take that every economist agrees with. what do critics say about this view?

10:43Kevin Warsh: A lot of people will say that, especially during the financial crisis, the bond buying was necessary to keep financial markets stable. And not only that, to really stop the economy falling into the sort of recession that could have resulted in a second Great Depression. The Fed was also headed at the time by Ben Bernanke, who was a scholar in this matter who'd written an awful lot to suggest that buying government debt would prevent a financial crisis resulting in a very serious impact on jobs and growth. So if you speak to a lot of Fed officials today, they see the use of the balance sheet as something which can be used to keep inflation on track, close to the sort of low and stable levels that they like to see.

11:36Claire Jones: So Claire, Warsh has said that he wants a, quote, regime change at the Fed. Now, I see that part of that will have to do with the shrinking of the balance sheet. But what else is he looking to change?

11:49Kevin Warsh: So one of the criticisms Warsh has had is that the Fed really needs to undergo quite a fundamental overhaul. We don't know exactly what he means by that. We know one element that we would like to see overhauled is the use of the balance sheet as a monetary policy tool. We also know that he'd like to revisit the relationship between the Federal Reserve and the U.S. Treasury. Now, I think this may be one of the factors that appeal to U.S. Treasury Secretary Scott Besant. Besant has also suggested that as U.S. Treasury Secretary, he'd also like to review how the Fed is governed.

12:34Claire Jones: I believe that the Fed should be able to set monetary policy on an independent basis. But the more creep we see within their mission, then the more it threatens their independence.

12:47Kevin Warsh: Both Walsh and Besant seem to have an idea of having a narrower mandate for the central bank and handing some powers over to Treasury. Exactly what that would look like in practice, well, I don't think anyone knows. The details aren't really out there, but we know that he shares Besant's view that there needs to be changes in the governance of the US central bank.

13:17Thank you.

13:55Claire Jones: So, Claire, let's talk about something that's definitely a part of monetary policy and in the Fed's toolkit, and that is setting rates. President Trump has been very vocal about how he thinks interest rates should be lower than where Powell's been setting them. So do we have a sense for what Warsh wants to do?

14:14Kevin Warsh: Walsh, like every other candidate that's gone for this job, has said he would cut rates in the short term. So we definitely know he wants interest rates lower than they are at the moment. However, the economic rationale he's provided for that isn't necessarily going to be agreed upon among the other rate setters at the Fed.

14:37Claire Jones: OK, so lower rates in the short term. But do you know where Walsh thinks the U.S. economy is heading more broadly?

14:43Kevin Warsh: Well, one thing he's been very clear about is that he thinks we're going to get an AI-induced productivity boom, and that's going to pave the way for interest rate cuts because the US economy is able to expand output without triggering inflation. However, he's not the only person setting US interest rates. The Federal Open Market Committee, which is the body that sets borrowing costs in the US, has another 11 voting members besides the chair that Walsh will need to convince of that view. So what Walsh is probably going to look to do is to have a more forward-looking approach and have a more kind of supply-side driven view of what's going to happen to the economy and try to ensure that other U.S.

15:36Kevin Warsh: rate setters make decisions on the basis of that.

15:39Claire Jones: Well, looking back into the past, you know, beyond Powell to their predecessors, how does that approach compare to other former Fed chairs?

15:49Kevin Warsh: We still don't know what approach Walsh is going to take exactly. But it's worth looking at what former Fed chair Alan Greenspan did during the late 90s. At that period in time, Greenspan was rather convinced that we'd see a productivity boom and wanted to keep interest rates lower than some of the others on the Federal Open Market Committee on the basis of that. Now what he managed to do was rely on an interpretation of the data to show that while it wasn't necessarily in the headline figures, there was a suggestion that the productivity boom was taking place, which enabled him to really persuade the majority of the committee to wait and see and keep interest rates relatively low.

16:39Kevin Warsh: So there is a parallel there in terms of what Walsh might do and what Greenspan did. However, what I'd stress is that what Walsh still needs to do is to find the data that really support his view that we are on the cusp of an AI-induced productivity boom. And unless he does that, I don't think you're going to get the rest of the Federal Open Market Committee really buying into his argument. And the evidence from the Greenspan era is that if he wants to do that, it isn't impossible. But he'll have to present his case in a very measured, analytical way.

17:23Claire Jones: How likely is it that Warsh is able to make any of the changes that he wants to? How much power does he really have in his role as chair of the Fed?

17:34Kevin Warsh: On the arguments for an AI-induced productivity boom, I think he could make some headway there if he takes a data-led approach. I feel like where he'll find it more difficult is on the balance sheet. The Fed, as we mentioned earlier, has been shrinking its balance sheet. However, the Federal Open Market Committee has recently paused that tightening of the balance sheet. And the reason they did that was because there were signs of tremors in money markets and signs that it was causing financial instability. So I think they're going to be quite reluctant to shrink the balance sheet more in the shorter term.

18:18Claire Jones: Yeah, that's a great point. Claire, is there any chance that Warsh is not confirmed by the Senate? How likely does this look?

18:25Kevin Warsh: If we weren't in the environment that we're in at the moment where the Trump administration had been so vocal in its attacks against the Fed and the president himself had been so, so vocal in calling for these massive decreases in interest rates, I think Walsh would sail through. He's got the experience. He's got the links with the Hill. However, given the environment we're in, I think it's going to be a pretty grueling confirmation hearing for Walsh too. Now, ultimately, I think he is going to get through the Senate, but he's going to face some pretty tough questions on the way. We know Tom Tillis, the Republican senator for North Carolina, is still reluctant to allow any one of Trump's candidates for the Fed to move through the Senate until the probe against Powell is dropped.

19:25Kevin Warsh: So there are still barriers here.

19:28Claire Jones: And what will you be watching for, Claire, as you continue to report on this? You've said a few times when I've asked you, you know, what's Warsh's plan for this? The answer is we don't know yet. So what will you be watching for?

19:42Kevin Warsh: I think that's it. I mean, as you've said, we've got a candidate here who's talked about regime change. We've talked about some big measures to the balance sheet. What we're really on the lookout for is detail. And I think the other thing is just a lot of these balance sheet policies, they sound like they're the sorts of things that would raise borrowing costs, at least in the longer term. And I think a lot of people are trying to square what Walsh is saying about the balance sheet with his desire to cut interest rates in the short term. So I think people just want to hear from him himself for him to really kind of say less about, you know, what he'd like to change at the Fed and how he's actually going to go about doing it.

20:31Claire Jones: Claire, thanks so much for coming on the show. No problem at all.

20:38Claire Jones: Behind the Money is hosted by me, Michela Tendera. This episode was produced by me and Safia Ahmed. Fact-checking by Simon Greaves. Sound design and mixing by Sam Giovinco. Original music is by Hannes Brown. Topher Forges is our executive producer. Cheryl Brumley is the FT's global head of audio. Thanks for listening.

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