Kevin Warsh Eyes Fed ‘Regime Change’ With Less Talk, New Models

0:00The thing about AI for business, it may not automatically fit the way your business works.

0:05Stephanie Flanders:At IBM, we've seen this firsthand. But by embedding AI across HR, IT, and procurement processes, we've reduced costs by millions, slash repetitive tasks, and freed thousands of hours for strategic work. Now we're helping companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business, IBM. For many men, mental health challenges aren't recognized until they've already taken a toll. Work pressure, financial stress, changing relationships, and traditional expectations around masculinity can quietly wear men down, often without clear warning signs.

0:44In Season 3 of The Visibility Gap, Dr. Guy Winch and his guests explore how these pressures show up, how to spot them earlier, and how men can access meaningful support. Listen to the new season of The Visibility Gap, a podcast presented by Cigna Healthcare. You need to make a huge presentation in an hour. Adobe Acrobat uses AI to take all your documents and generate a presentation with a single click. Build slides quickly and streamline the process. Need a last-minute pitch deck? Do that with Acrobat. Need to level up your presentation design? Do that with Acrobat. You have 30-plus documents that need to be simplified into a proposal.

1:25Do that. Do that. Do that with Acrobat. Learn more at adobe.com slash do that with Acrobat. Bloomberg Audio Studios, podcasts, radio, news. He would not answer any question that might in the smallest way disagree with Donald Trump. He proved to all who were watching that Kevin Worsh will be a great sock puppet for Donald Trump. I'm committed to ensuring that the conduct of monetary policy remains strictly independent, equally committed to work with the administration and Congress on non-monetary matters that are part of the Fed's remit, and I commit myself to accountability.

2:21Stephanie Flanders:I'm Stephanie Flanders, head of government and economics at Bloomberg, and this is Trumponomics, the podcast that looks at the economic world of Donald Trump, how he's shaking the global economy, and what on earth is going to happen next. And this week, we're turning our attention back to the Federal Reserve. We're recording this on the morning of Wednesday, April 29th, a few hours before what is likely to be Jay Powell's final meeting, chairing the board. Now, usually that would be a rather stupid, badly timed thing to do. But with one exception, and we'll get to that, there's not a lot hanging on this meeting.

2:56Stephanie Flanders:The big focus is on the man who's likely to be leading the world's most important central bank at the next meeting. Trump's pick, Kevin Walsh. Now, we had an episode back in February, I encourage you to go and listen to it, about what we could expect from a Fed led by Mr Walsh, featuring my friend and the former senior advisor at the New York Federal Reserve, Krishna Guha, who's now vice chairman and head of economics and central bank strategy at Evercore ISI. Well, since then, a lot has happened with implications for that future Fed, the Iran war, for starters. Also, a bit more evidence on how AI might or might not be paving the way to looser policy in the US.

3:35Stephanie Flanders:And most recently, we had a very lively confirmation hearing for Mr Walsh in front of the Senate Banking Committee on April 21st. I was away for the hearing, but catching up afterwards, looking at the coverage, It seemed how you felt about it depended pretty heavily on where you sat. So it made me want to check in with Krishna again, how he was looking at a Walsh Fed. Krishna, thanks so much for doing this again and on Fed Day, no less. Great to see you. Now, we were going to try and save your breath. So we've got a few top lines here from what you told us in February, and then we'll get on to what you think now.

4:11So I think it is true that Kevin Walsh has, for most of his career, has channeled and represented what one might think of as small C conservative, Republican-leaning economic thinking and principles that has generally been more concerned with inflation than the labor market, let's say, more focused on supply-side issues than demand-side management. And so I think there is an aspect that is channeling a set of thinking on one side, if you like, of the political and economic debates. I think it's also the case that Kevin believes that the really big inflation risks come when you have a combination of fiscal expansion on the part of the government and money financing on the part of the central bank.

4:59So Kevin would say the inflation risks today are completely different from the inflation risks that were there in the early phase of the pandemic, which is why I was a hawk then and I'm a dove now. I think that the crude version of concerns about Walsh, which is he's super hawkish on inflation interest rates and he's super hawkish on QT, just don't bear particularly close examination. That's not what we should be worrying about. That doesn't mean that there are no points of vulnerability or things that we should be attentive to in the case of a Walsh Fed. I think the question is, it's fine and indeed, I think, very legitimate to critique some of the shortcomings of traditional Fed models and backward-looking data dependence.

5:44But it's going to be very hard to replace that with something that is coherent and systematic and well-communicated. And that could go badly wrong if Walsh were to turn his back on the old ways of doing business without having figured out a fully coherent set of approach or set of approaches to replace it.

6:07Stephanie Flanders:So first things first, Krishna, was there anything that struck you from Kevin Walsh's testimony that's led you to change your expectations for his kind of Federal Reserve in any way? Not so much changed my view, but I thought there were some very interesting parts to that hearing. First and foremost, Kevin really doubled down on his promise of, quote, regime change, end quote, at the Fed. Now, there's still a lot of gaps in terms of filling out what that really means. But I think it's very clear that he's presenting himself not just as a change candidate in general, but as a break with his immediate predecessors.

6:50So not just Powell, but that period of relative continuity from Bernanke to Yellen to Powell. To the extent that Walsh has a role model in central banking, it's really Greenspan, not one of his immediate predecessors.

7:05Stephanie Flanders:Yeah, and I was struck that he was pretty straightforward in blaming the inflation after COVID on central bankers, which the central bankers who were there at the time, I've never got them to really admit that. He was critical of the new framework for inflation targeting that was introduced just around that time. What key aspects of regime change were you thinking about? Well, I think we should break that down into framework tools and communication, right? So with respect to the framework, I mean, you started there already, right? Highly critical of the framework that the Fed put in place during the pandemic.

7:44And in fact, of course, the Fed has itself revised. But looking to develop a difference, and he would say better understanding of the inflation process in the inflation outlook through new models, more extensive modeling of the supply side, not just new Keynesian modeling of the demand side, looking at different and potentially better ways of measuring underlying inflation. He's talked about wanting to lean more on trend mean or median as opposed to the core PCE measure that the Fed has typically used to represent underlying inflation. On tools, there are going to be important changes on communication too.

8:23Now, Walsh wants to get out of the business of forward guidance. I think many would agree that that was overdone in recent years. But he wants to go further than that. He thinks that central banks have made a fetish out of communication. They just say too much, talk too much. He wants to say less, talk less. And I think that's going to be quite an adjustment for us to get used to after a long period in which the Fed and other central banks embraced the idea that by being more transparent, by sharing more information with the markets, they would actually make policy not just better understood, but more effective too.

8:59Stephanie Flanders:I was very struck by what he said about communications because it is interesting, even in your and my sort of time of looking at markets and thinking about monetary policy, the expectations around communications have gone up and up. The bond markets, you could argue have been really spoon-fed by the Fed and got used to thinking they know everything about what the Fed's going to do ahead of time. Walking back from that really means that you're promising to inject more uncertainty into markets and potentially volatility. However much you might want to get there in the end, it sounds like quite a dangerous sort of scary transition.

9:36A hundred percent. That's exactly my own view. I think that particularly if Kevin is also proposing that the Fed should change some of its framework and its operating practices. If at the same time you also pull back from your communication, you're certainly going to have a period of more volatility and uncertainty. And so you've got to be careful how far you go in that direction. I also think separately that Kevin himself may run into a very simple problem, which is that fundamentally the reason why central bankers like to communicate a lot is because it allows them to shape the market rate path and therefore advance their own objectives in terms of monetary policy, either easing things or tightening things or keeping them where they are.

10:28The problem Kevin's going to run into sooner or later is the market's going to price something he doesn't like. And then the question is, well, am I going to stay silent or am I going to say something about it?

10:39Stephanie Flanders:I think that goes to whether or not it's credible to make this promise. You know, there's a big tool that you're just saying, I'm not going to use it. And I'm even going to put up with quite a lot of volatility, some of it based on maybe wrong expectations, in order to give up that tool. Once he actually gets there, I just wonder if that's going to last. But I guess if he did really get rid of it, then you'd be going back not to a Greenspan Fed, but more like a Volcker Fed. I mean, famously, Paul Volcker raised interest rates on a Sunday night to buy two percentage points and actively wanted to shock the markets.

11:13Yeah, I don't think there's any going back to Volcker. I don't even think there's any going back really to Greenspan's era of, you know, just providing very ambiguous Delphic statements and leading the market to figure out, you know, what's going on. So I think Kevin's going to have to try to find a middle way. I think it's certainly true that the Fed and many other central banks probably talk more than they necessarily need to, in aggregate at least, when you count all the different speakers. And there are lots of things that could be done to improve the signal-to-noise ratio in central bank communications and to sharpen up the distinction in the way you talk about different things.

11:55The central bank should, in my view, categorically communicate very clearly and comprehensively about its reaction function. It should also understand that it's very different when it talks about its understanding of the economic outlook. That is something where it has some insight, some expertise, good stuff, good data, but fundamentally doesn't have a deep forecasting edge over the market. and should in general be quite humble. Plenty of things that can be improved, but just backing away from communication, I think, ultimately won't work.

12:32Stephanie Flanders:One of the areas where he was delphic and indeed ambiguous was in answering questions around, for example, whether Donald Trump lost the 2020 election. And this was one of the things when I said people, depending on where they sat, had a different focus. You know, there were certain people in the markets who were focusing on the stuff that you've just talked about. But others, maybe of a more political mindset, not least Elizabeth Warren, focused on him not being willing to say anything that might offend Donald Trump. You, in your own note, said it was jarring, which you're very careful with your words.

13:06Stephanie Flanders:I think shocking would be the word other people might use if I sort of translate it out of Krishna speak. But did you also find it concerning? I think that while it is a sad statement on The Times that it is controversial to state who did or didn't win the 2020 election, I think you could, if you were being generous, make an excuse to Kevin that, look, you're starting to get drawn into political controversy. This is not a question that is pertinent to the role for which he's being considered, which is that of Fed chair. But what I found jarring and somewhat concerning was the fact that Kevin did not seem to feel able to say the words tariff and inflation in the same sentence.

13:51Now, that is in his core wheelhouse as Fed chair. It is central to understanding the evolution of inflation, including, by the way, why one might be cautiously optimistic that inflation will come down once these tariff effects have washed through the price series. I think it's quite problematic that the next Fed chair apparently feels unable to say something which is essentially a matter of fact among economists, that tariffs have pushed up the inflation rate over the last year, even though this may well ultimately prove to be a one-time change in the price level and not underlying ongoing inflation.

14:43It would be perfectly fine for Walsh to make that distinction. Powell's made that distinction. Walsh could even make it more sharply. But I think it doesn't help your credibility if you can't accept the basic fact that tariffs pushed up prices.

14:59Stephanie Flanders:And without getting too into the weeds, I guess related to that, you pointed in your note talking about potentially changing the focus of the sort of the inflation measure that he's going to be most focused on. And there is a suggestion that in that choice of rate, because it's sort of adjusting out of away from tariffs, he's kind of escaping that issue around tariffs, but also shopping for measures which support lower rate. So, look, I think it's unfortunate that he backed into that discussion of inflation measures by way of trying to avoid talking about tariffs. Right. Because, of course, one of the measures he emphasised a trimmed mean.

15:39Trimmed mean is where you just lock off the outliers.

15:42Stephanie Flanders:You lop off the things that are increasing inflation. Yes. If you're trying to understand the underlying trajectory, the central tendency of prices, you may well want to exclude outliers, providing you're doing it in a fairly symmetric way to the downside as well as the upside. But of course, what was politically convenient at this point in time is that, of course, the categories that are going up the most and are getting trimmed out of your trimmed mean are, of course, all the things that have tariffs on them. Right. So I think that was unfortunate. But there is a substantive economic sort of question here, which is we do want to focus on underlying inflation and the medium term inflation outlook.

16:23And it is the case that core PCD inflation, the metric the Fed typically refers to, is just one of a number of measures that try to capture what that underlying trajectory of inflation is. Now, in the present, Chair Powell has been saying, look, core PC inflation continues to be elevated. In fact, it's just going up still to crest in the low threes. But Chair Powell is saying that this is overwhelmingly because of tariffs. And if you take out tariffs, inflation X tariffs is running a lot closer to 2%. When Walsh points you to trimmed mean on the Dallas version, saying 2.3%, he's basically saying the same thing Powell is saying, which is if you trim out the tariff goods, inflation's a bit above too, but it's not anything like as high as it looks.

17:18Stephanie Flanders:He's at least here. He's sticking to the idea of being much less clear in his communications. Well, yeah. And I think the problem also is that I think it's legitimate to say, look, we want to look at a range of measures of underlying inflation. But if it looks like you're shifting the goalposts, you're shopping around for metrics that suit your story, again, that's just going to weaken your credibility. And that's not going to wash with the rest of the committee, never mind with financial markets. But it links to something else, which is which Kevin Walsh showed up, the hawkish Kevin or the dovish Kevin.

17:53Stephanie Flanders:Some of the sort of Wall Street commentary that I read felt that he is slightly more hawkish. Kevin Walsh had turned up and was struck in particular about the way he talked about the mandate only in terms of inflation, when I think even sort of cursory Fed watchers know that the Fed famously has a dual mandate for full employment as well, even though it tends to talk more about inflation. Did you read anything into that? I certainly heard the same things that those folks are talking about, But I interpret them in a very different way. I think we want to make a distinction between two things. One is how Kevin thinks about the Fed's mandate.

18:32And the second is how he's positioning on policy. So on the mandate, it's very clear, it's been the case for a long time, that Kevin Walsh is somebody who believes that the Fed dual mandate can, to a large extent, be reduced in practice to a single mandate for inflation because in the longer run, in Kevin's view, consistent with many conservative economists, in fact, consistent with many economists, in the longer run, the Fed doesn't get to affect these real variables and the best contribution it can make to keeping unemployment low is to keep inflation low and stable. So Kevin would say that he's legally compliant with the dual mandate, but he's really focused on inflation stability as being the foundation for everything else, right?

19:20And so that necessarily means that he's going to be less twitchy on labor market weakness or risk of labor market weakness than his recent predecessors. But I personally think that's a mistake to jump from that to say that he's therefore being more hawkish. I think what we're saying here is we're seeing the new Fed chair retire an old form of Fed dovishness and replace it with a new form of Fed dovishness. Farewell, labour market risk dovish, hello, AI productivity dovish.

20:11Stephanie Flanders:Normal human beings would be listening to this and wondering how on earth we had not got to the implications for interest rates, the short-term interest rates that the Federal Reserve has control over in all of this conversation. But I guess the implication of what you just said is it might not matter a whole lot. In the near term, let's say, next quarter or two certainly, and plausibly beyond that, there isn't a live debate about changing the policy rate in the US. I think it's very clear that with the oil inflation shock coming on top of all the prior inflation shocks, including the tariff shock that's only now cresting, the Fed is going to be firmly in the mode of policing inflation developments, at least here through the end of the summer and potentially long beyond that, before they can return to any consideration of the case for rate cuts.

21:02At the same time, I think they're very, very far away from contemplating any serious consideration of a rate hike. So the next few Fed meetings simply aren't live, And what happens around Iran, the war energy and the economic data is really in the driving seat. But I think it still matters what position the new chair is starting to set out. And I think he is setting the foundations for making the case potentially later this year to shift from backward looking policing of current inflation shocks to forward-looking monetary policy with rate cuts motivated by an expectation that AI and technology more broadly will raise the potential growth rates of the US and reduce inflation pressures going forward.

22:04So I think what we're seeing here is that Walsh recognizes for the time being, there is no debate about rates. You're in this monitoring, policing phase. But I think he's positioning so that at the earliest responsible moment, when he can say the tariff stuff has rolled over and the oil inflation indeed is looking like a one-time hit to the headline prices, then he can say to the committee, and now is the time to look forward and to ask what the inflation outlook looks like over the next several years and make the case that that is tech-driven disinflationary, and therefore the Fed should be willing to move to consider cuts, not because the labor market's weak, but because tech is going to drive disinflation going forward.

22:56Stephanie Flanders:You said there's Not very much live about these next few meetings and the meeting that's happening after we speak today on Wednesday. Except there was one question today, which is whether or not Jay Powell is going to stick around once Kevin Walsh is confirmed and in place in the Fed. There's been a lot of background to this. The investigation and the case against Jay Powell on grounds of excessive expenditure on the Fed renovation, that has been withdrawn, at least for the time being. That's what's allowed Kevin Walsh's confirmation to go forward. If we imagine that we're in a world in a day's time people are listening and he said that he's going to stick around at least for a bit, does that change the first few months of Walsh's tenure, do you think, significantly?

23:42I think it does matter if Powell stays or goes. If he stays on, if we're in a world where, you know, he's staying on for a bit, It does slow the transition in the composition of the Fed board and the FOMC. It means it takes longer for that seat to become vacant and for Trump to be able to put in another appointee, presumably a Walsh ally, onto the board. And so it slows down a little bit the process by which Kevin is going to be able to build majorities in favor of some of the changes that he wants to make that require votes either of the Fed board or of the FOMC. But I don't see Powell staying on to lead the resistance.

24:25I think he has a sort of narrow and circumscribed view of why it could be appropriate for him to stay on. That would be really to see out the remaining aspects of this legal threat to Fed independence from the DOJ investigation to make sure that all the loose ends are firmly tied up. And in doing so, not just to settle the question in this case and the precedent, but also to avoid any suggestion that he walked under pressure with an implied threat that if he didn't, they'd come back at him with more legal suits. I think he will feel it as to be very important that institutionally he leaves having upheld the independence of the Fed to the greatest of his ability.

25:19And I think if we're in a world where he's staying, that's the reason why he's staying, not because he wants to fight Kevin Walsh over regime change to frameworks, balance sheet or communications. That's for the larger committee to assess. And I think that conduct of Fed policy, Fed institutional reform will be a negotiation between the new chair and the old committee. But Powell, I think, to the greatest extent, even if he's around, will try not to be at the forefront of that.