How a Former Fed Vice-Chair Is thinking About the Next Fed Chair

Episode Summary

Executive Summary: The episode examines Kevin Warsh’s Fed chair nomination through the lenses of Fed independence, Treasury coordination, monetary-policy communication, and balance-sheet strategy. Former Fed Vice Chair Richard Clarida argues Warsh is a plausible choice, but his effectiveness will depend on persuasion inside a committee, managing presidential pressure, and navigating a more volatile market environment if forward guidance is reduced.

Main Topics: Warsh’s nomination and political/market reception (Priority: 5/5): The hosts discuss how unusually split the reaction has been to Trump’s choice of Kevin Warsh for Fed chair, noting support and opposition from unexpected quarters and raising questions about how he will balance independence with presidential expectations for lower rates. Fed chair vs. Treasury coordination (Priority: 5/5): Clarida argues the Fed must remain independent in setting rates, but a collaborative working relationship with Treasury matters for Treasury-market liquidity and bank regulation coordination, especially with Scott Bessent likely at Treasury. How Fed decision-making actually works (Priority: 5/5): The conversation explains that the Fed chair’s real power is persuasion, not unilateral control. Clarida describes FOMC dynamics, pre-meeting consultations, agenda-setting, and how chairs shape outcomes through process and framing. Forward guidance and communication tools (Priority: 4/5): Warsh’s skepticism toward forward guidance is contrasted with the post-GFC era when it helped prevent premature tightening. Clarida says these tools were crucial at the zero lower bound but may be less necessary in normal times. Balance sheet policy and a possible new accord (Priority: 4/5): The discussion explores Warsh’s long-running criticism of QE and the size/composition of the Fed’s balance sheet, plus the idea of a Treasury-Fed understanding on maturity composition and reserve management. Models, supply-side thinking, and AI/productivity (Priority: 4/5): Warsh’s critique of demand-heavy macro models is reframed as a legitimate supply-side concern. Clarida agrees productivity matters, but warns AI may be disinflationary only later, while near-term capex could raise demand and inflation. Central bank independence under political pressure (Priority: 5/5): The hosts and Clarida discuss Trump’s pressure on Powell, possible legal/political challenges, and whether Powell will remain on the Board after his chair term. The broader issue is whether institutional independence can withstand recurring political attacks.

Key Arguments: Warsh is a sensible choice on practical grounds because he may work well with Treasury Secretary Scott Bessent on issues where coordination is necessary, even though the Fed must not be dominated by Treasury. The Fed and Treasury need coordination on Treasury-market liquidity and bank regulation, because the Fed is the government’s fiscal agent and both Treasury and FDIC-linked agencies have regulatory roles. The Fed chair’s authority comes mainly from persuasion, agenda-setting, and pre-meeting coalition-building; the chair has one vote like everyone else. Warsh’s historical hawkishness should be viewed in context: he was involved in crisis response and has largely been a consistent critic of post-Bernanke Fed policy from a hawkish angle. His recent support for rate cuts is not necessarily a reversal, because the existing FOMC was already leaning toward further cuts and Powell’s committee had moved into easing mode. Forward guidance was a major innovation born out of desperation at the zero lower bound; it helped suppress bond-market volatility and prevent premature tightening after the GFC. Reducing forward guidance would likely increase interest-rate volatility, though perhaps toward more normal pre-GFC levels rather than crisis-era extremes. The Fed’s balance sheet is complicated by interest on reserves: QE now mostly changes the maturity composition of government debt rather than simply 'printing money.' Warsh’s critique of macro models can be read as a call to better incorporate the supply side and productivity growth, not necessarily as a rejection of data or economics entirely. AI could be disinflationary in the long run via productivity gains, but near-term investment spending to build AI capacity may boost aggregate demand and complicate inflation management. Even strong central bankers can have reputational tradeoffs: inflation failures can tarnish a tenure, but crisis management can preserve or elevate a Fed chair’s legacy. The subpoena/investigation pressure on Powell raises questions about political attempts to punish policy independence, but Clarida expects courts and institutional structure to preserve Fed autonomy.

Data Points: FOMC members: 12 voting members - Clarida notes major monetary policy decisions require an affirmative vote by a 12-member committee. Additional Reserve Bank presidents in consultations: 7 non-voting Reserve Bank presidents - Clarida describes Powell’s pre-meeting outreach to 18 people total, including 7 non-voting presidents. Powell’s outreach: 18 individual calls or face-to-face meetings before each meeting - Illustrates the chair’s coalition-building role before FOMC meetings. Zero-rate period after GFC: 7 years - Clarida says rates were at zero for seven years after the global financial crisis. Rate hikes under Yellen: December 2015 - Clarida cites this as the first hike after the long zero-rate period. Powell easing cycle start: September 2024 - Clarida notes the committee had already begun cutting rates by then. Rate target perception: "two-point-something" inflation target - Clarida’s characterization of how the Fed behaves once inflation is near but above 2%. Late-90s funds rate: 6.5% - Clarida says the federal funds rate reached 6.5% by 2000 during Greenspan’s tightening cycle. Zero-bound context: After Lehman Brothers - Forward guidance became important once rates hit zero after the financial crisis shock. Fed chair term end for Powell as governor: January 2028 - Clarida says Powell’s governor term runs through January 2028.

Pivotal Quotes: "the power of the Fed chair is the power of persuasion, because at the end of the day, he or she only has one vote" — Richard Clarida: Explaining how the chair influences FOMC outcomes despite formal committee structure "forward guidance really took on an important role when the Fed was trapped at the zero bound" — Richard Clarida: Describing why forward guidance became central after the global financial crisis "I think you hit the nail on the head. I think the most robust prediction I would make is it would increase to some extent market volatility" — Richard Clarida: On the likely market impact of reducing forward guidance

Implications: Warsh would likely pursue a more restrained, less communication-heavy Fed, but he’ll need to preserve independence while managing Trump’s pressure and market sensitivity. A shift away from guidance could mean more rate volatility and a less predictable policy regime.