A hawk in dove's clothing?

Is Warsh a Keynesian or a NeoFisherian?

Trump just named Kevin Warsh to chair the Federal Reserve Board. As is almost always the case, the media is equating a preference for lower interest rates with “dovishness”. I know that people are sick of me prattling on about how one should never reason from an interest rate change, but the beatings will continue until the moral improves.

Here’s Bloomberg:

Warsh aligned himself with the president in 2025 by arguing publicly for lower interest rates, going against his longstanding reputation as an inflation hawk. . . .

“The two big questions are who’s the real Kevin Warsh and does that evolve?” said Michael Feroli, chief US economist at JPMorgan Chase & Co. “I presume at the outset he is going to be dovish, but does that persist as we move forward a year or two or more?”

There are cases where a person’s preference for lower interest rates implies a dovish view on monetary policy. This is especially true of economists that look at the world from a Keynesian perspective. But Warsh doesn’t seem all that Keynesian:

Warsh resigned from the Fed in 2011 shortly after it embarked on a second round of bond purchases to shore up a crisis-scarred economy. He has since been critical of the Fed’s balance-sheet expansion, and now argues that by more aggressively reducing the size of it, the central bank would also be able to cut interest rates more.

That openness to lower rates marks a change for Warsh, who was once so cautious about inflation that he called for higher rates even in the depths of the financial crisis.

How shall we interpret that sort of seeming inconsistency? Paul Krugman looks at things from a Keynesian perspective, and not surprisingly is dismissive of Warsh:

As I write this, many media reports are describing Warsh as a monetary hawk. That’s a category error. Warsh is a political animal. He calls for tight money and opposes any attempt to boost the economy when Democrats hold the White House. Like all Trumpers, he has been all for lower interest rates since November 2024.

I share Krugman’s skepticism (I would have preferred Chris Waller), but I suspect that there’s something else going on here. Warsh may still be a policy hawk but sees an opportunity to generate lower interest rates via a NeoFisherian policy channel.

At the risk of slightly oversimplifying the distinction, Keynesians see lower interest rates as inflationary because they assume market interest rates will fall relative to a fairly stable natural (or equilibrium) interest rate. NeoFisherians view lower interest rates as disinflationary because they believe lower rates mostly reflect a fall in the (nominal) natural rate of interest.

The Bloomberg quote above suggests that Warsh intends to get to lower rates with a contractionary policy of reducing the size of the Fed’s balance sheet. If successful, this policy could reduce the natural interest rate, allowing for what Wall Street calls “hawkish rate cuts”.

To be clear, I am not at all certain that this approach will be successful. But FWIW, the market reaction was consistent with a small NeoFisherian effect. Here’s the FT:

US stocks slipped and the dollar strengthened on Friday as investors reacted to Donald Trump’s nomination of Kevin Warsh as chair of the US Federal Reserve.

The S&P 500 index was down 0.8 per cent in early afternoon trading, while the Nasdaq dropped 0.9 per cent.

The dollar rose 0.9 per cent against a basket of its key trading partners and a blistering rally in precious metals went into reverse.

In the end, people tend to overrate the importance of Fed chairs, as the Fed has a great deal of institutional inertia. Here’s Krugman:

The silver lining to his appointment is that he shouldn’t be able to do much damage, although with one big caveat (see below). The Fed is a republic, not a dictatorship; key decisions are made by a committee in which the chairperson has only one vote. . . .

Absent a crisis, my prediction is that the majority of Warsh’s colleagues will largely ignore him, albeit without expressing their contempt openly. Even a coalition among the Trump appointees to the Board of Governors – Warsh, Bowman and Miran – won’t be enough to overturn the responsible monetary policy stewardship of the other governors.

If I am correct, then Krugman overestimates the extent that Warsh would try to implement Trump’s preferred (dovish) policy. I wonder if Warsh fooled Trump into assuming he had dovish views by advocating rate cuts to be achieved by reducing the size of the Fed’s balance sheet. Time will tell.

(I happen to favor a smaller Fed balance sheet. But it will be difficult to achieve without a change in bank regulation.)

Kevin Hassett would have been a more loyal lackey, but Trump had to back off at the last minute when it became clear that his attacks on Powell had backfired, making it unclear if Hassett could get confirmed, and extremely unlikely that Hassett could effectively lead the Fed if he were confirmed.

As we saw with Greenland, even “dictators” do not have unlimited power.

PS. Another FT article has a confusing claim:

Warsh is now certain the Fed should overwrite its forecast of modest growth and above target inflation with something much more bullish, reflecting a productivity miracle from artificial intelligence that will, he says, be “a significant disinflationary force”.

Interest rates should fall sharply, he wrote in the Wall Street Journal last year, giving relief to main street.

I don’t get it. Given the Fed’s 2% inflation target, faster productivity growth means faster NGDP growth, which means higher nominal interest rates. Another example of “reasoning from a price level change”?

PPS. You want an optimistic take? Trump is too dovish. Warsh is too hawkish. A Trump appointed Warsh is just right? :)

Or how about this: With the coming AI revolution, none of this matters.