Outside the Box: Warsh would be strange pick as Fed chair for a president who says he cares about jobs

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Daniel Acker/Bloomberg

Kevin Warsh

President Donald Trump is considering nominating former Federal Reserve Gov. Kevin Warsh as the next chairman of the Fed, but Warsh would a curious choice for a president who says he is obsessed with “jobs, jobs, jobs.” When America faced its greatest unemployment crisis in decades, Warsh was skeptical of stimulus and doubtful that the jobs could return.

With unemployment close to 10%, Warsh publicly turned on his mentor, Fed Chairman Ben Bernanke, injecting a dramatic element into the usual Fed drabness. In November 2010, five days after voting with Bernanke on the second quantitative easing program, Warsh published an op-ed trashing the policies he had just voted for.

As former Fed Vice Chair Alan Blinder wrote, “Bernanke must have had an ‘Et tu, Brute?’ moment.”

What was Bernanke’s sin that he deserved this betrayal from the man described as his “right hand” and “protector”? Trying too hard to bring down unemployment. Seriously.

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It’s an important episode to revisit as Warsh campaigns to succeed Janet Yellen as Fed chair. The Wall Street Journal reports that Warsh is aided by his billionaire father-in-law, Ronald Lauder, a longtime friend of President Donald Trump’s. Lauder is lobbying Trump on his behalf, and Warsh formally interviewed for the job with the president last week.

He’s emerged as the favorite to get the job.

Warsh joined the Fed, whose mandates include maximum employment, price stability and moderate long-term interest rates, in 2006. Throughout 2008, with the banks on the ropes and the economy weakening, Warsh wouldn’t let go of his obsession with inflation.

As late as Sept. 16, 2008, the day after Lehman Brothers went under, Warsh told his colleagues, “I’m still not ready to relinquish my concerns on the inflation front.” Many commentators believe this paranoia about inflation exacerbated the crisis.

Almost immediately after the financial system was saved, Warsh started to doubt how much could be done to help the real economy and staunch the massive job losses.

In 2009 he embarked on a yearlong crusade to convince other members of the Fed’s policy-making committee that trying to lower long-term interest rates to generate economic demand would spark a debt crisis. Warsh’s warning was that, unless the Fed pulled back on the stimulus, markets would lose faith in America.

In March 2009 he told his colleagues that, “if the Fed is perceived to be monetizing the debt and serving as a buyer of last resort in the name of lowering risk-free rates, we could end up with higher rates.” But just the opposite happened — even after the Fed added trillions more to its balance sheet.

In September 2009, with unemployment at 9.8% and rising, Warsh started publicly pushing for the Fed to pre-emptively let up on the monetary gas pedal or risk runaway inflation. Warsh believed the Fed should pull back on the accommodation aimed at bringing back normal levels of employment before the jobs actually showed up.

Fed watcher and now Bloomberg columnist Tim Duy wrote in response to Warsh’s speech: “the spate of FedSpeak in recent days leaves one with the uneasy feeling that monetary policy makers are more willing to use unconventional monetary policy to support Wall Street than Main Street.”

In June 2010 Warsh said the Fed staff’s projection that unemployment could get down to 5.25% without sparking accelerating inflation was probably too optimistic. That is, the Federal Reserve should not tolerate unemployment going that low. Of course, today unemployment is 4.5% and inflation keeps coming in below the Fed’s target of 2%.

By November 2010 the hoped-for economic snapback hadn’t materialized. Unemployment was close to 10% and core inflation had fallen below 1%. Chair Bernanke and Vice Chair Yellen saw a clear need to act.

At the same time, the conservative movement had soured on the Fed.Conservatives like Paul Ryan and Mike Pence attacked Bernanke and predicted, in the case of Pence, that QE2 would “monetize our debt and trigger inflation.”

It is in this context that Warsh’s intentionally loud break with Bernanke should be viewed. It transformed his public profile.

Bernanke’s right-hand man and one of the “four musketeers” of the bailouts had almost overnight become, as Zero Hedge put it, the “vocal critic of the Chairsatan.” This transformation allowed Warsh to go on to work at the Hoover Institution, advise Mitt Romney and Jeb Bush, and be on the short list for top economic jobs in a Republican administration.

But, what about the 10% unemployment? If it was a priority, Warsh had a funny way of showing it. He told his colleagues at the November meeting that he would dissent against the Bernanke policies if inflation moved up to 2% “even if unemployment were unacceptably high.”

If Trump picks Kevin Warsh for Fed chair, the recent run of impressive job gains will run up against a conservative orthodoxy committed to higher interest rates, a much smaller balance sheet, and an end to the Fed’s focus on maximum employment.

Sam Bell is a research adviser to the Fed Up Coalition.