Warsh’s challenge: Navigating Fed independence and Trump’s demands

Economist Pau S. Pujolas says Kevin Warsh is a 'great pick' as the next Federal Reserve chair, but it's unclear if he'll be able to maintain his independence.

WASHINGTON — Kevin Warsh has sought the job of Federal Reserve chair since U.S. President Donald Trump first considered him for the position nearly a decade ago. Now that he is in line for the job, the enormity of the challenge ahead of him is clear.

To be effective, Warsh must gain the trust of at least three constituencies: the committee of Federal Reserve officials whose votes he will have to win to change interest rates; the financial markets, which can undermine his efforts to reduce borrowing costs if they think he is acting politically; and not least Trump, a former real estate developer with an exquisite sense of just how much difference a cut or increase in interest rates can make for those with large debts, whether they are businesses, households or a government.

“He has to thread that needle,” said Raghuram Rajan, an economist at the University of Chicago and former head of India’s central bank. “If you are seen as too pliable to the administration, you lose the support of the members of the (Fed), you become ineffective in creating consensus.”

Yet if he alienates the White House, Rajan said, Warsh runs the risk of putting the Fed back in the White House’s sights. Under Trump, the current chair Jerome Powell has come under relentless fire for not cutting interest rates as quickly as the president would like, and is now under criminal investigation by the U.S. Department of Justice. Powell has called the investigation a pretext to force him to lower rates.

Warsh may also face a bumpy confirmation process in the Senate, where two Republicans have already said they will oppose his nomination unless the criminal investigation is resolved. One of them, Thom Tillis from North Carolina, is on the banking committee, and could prevent that panel from approving the nomination if he and all Democrats vote against it. Tillis repeated Friday that he would oppose Warsh until the U.S. Justice Department investigation is resolved.

And Democratic Sen. Mark Warner from Virginia, who is also on the committee, said that “It is difficult to trust that any chair ... selected by this president will be able to act with the independence required of the position” with the threat of prosecution hanging over Powell.

Trump told reporters Friday that he didn’t want to ask Warsh to agree to cut rates because that would be “inappropriate,” even if “it probably would be allowed.”

“I want to keep it nice and pure,” Trump said. “But he certainly wants to cut rates. I’ve been watching him for a long time.”

That’s a shift in tone from comments Trump made just last month on social media calling for lower borrowing costs and adding, “Anyone who disagrees with me will never be the Fed chairman!”

And there may be even more drama ahead: Powell, as part of the Fed’s complex structure, could remain on the Fed’s governing board until his term expires in January 2028, as well as its rate-setting committee, even after chairmanship ends in May. That would leave Warsh facing a situation no Fed chair has dealt with in 80 years: A former chair potentially acting as a counterweight to the new leader of the Fed.

Demonstrating some independence from the White House will likely be Warsh’s biggest challenge. Alan Blinder, a former Fed vice chair, said that the most important unknown is what promises Trump extracted from Warsh in return for nominating him to lead the U.S. central bank. The Princeton University economist said he worries about the private conversations between Trump and Warsh about what Fed policy needed to be.

“We all know Donald Trump -- he wants a loyalty pledge of some kind,” Blinder said. “I hope Kevin Warsh didn’t give one.”

Blinder said that Warsh does have experience with markets and monetary policy, which are good preparation for the job. But more importantly, Warsh is a people person who has the skills to influence other Fed officials when debating policy.

“The one thing he has in abundance is personal and diplomatic skills,” Blinder said. “He knows how to get along with people. He’s expert at that. He’s very likable.”

Still, as Fed watchers often note, the central bank is more than just the chair. There are 19 officials on its interest-rate setting committee, with 12 actually voting on policy. The voters are the seven members of the Fed’s governing board, as well as the president of the Federal Reserve Bank of New York, and four of the other 11 regional bank presidents on a rotating basis.

Warsh will face a divided committee that doesn’t appear ready to cut rates nearly as much as the president wants. Earlier this week, the committee voted 10-2 to keep rates unchanged. In December, they forecast that they would cut rates just once this year. Seven of the 19 officials, likely worried about still-elevated inflation, signaled in December that they didn’t see the need for any further cuts.

The Fed typically operates by consensus. When the committee agreed by a 9-3 vote in December to cut its key rate by a quarter-point to about 3.6 per cent, it was the most dissenting votes in six years. Chairs can be outvoted, though that hasn’t happened since 1986.

“Warsh will have to convince his colleagues that rate cuts are appropriate this year, an argument that he is unlikely to win unless the labour market shows renewed signs of weakening or inflationary pressures ease materially later this year,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.

And Warsh has frequently taken aim at the Fed’s US$6.6 trillion balance sheet, which ballooned after the 2008-2009 Great Recession and the pandemic, as the Fed bought trillions of dollars of government and mortgage-backed bonds in an effort to lower longer-term interest rates.

He has charged that the massive bond-buying enabled Congress to ramp up spending without concern for higher borrowing costs. Warsh also argues that reducing those holdings will lower the amount of money in the economy, which would temper inflationary pressures and allow the Fed to cut its short-term rate further.

But selling off the Fed’s bond holdings will be a fraught exercise because banks have become accustomed to the large amounts of cash in the financial system that it provides

Christopher Rugaber And Josh Boak, The Associated Press