Trump’s Choice for Fed Chair Provides the Irony of the Day

Please consider Kevin Warsh’s statements on the Fed.

The Daily Economy reports Warsh: The Fed Helped Create Fiscal Dominance

Federal Reserve chair nominee Kevin Warsh argues the Fed has drifted far beyond its mandate, becoming a “general-purpose agency of government.”

For decades, economists have warned about the risk of fiscal dominance. Over the past year, the topic has graduated to news headlines. At first glance, the US’s deteriorating fiscal situation appears to be the culprit.

Kevin Warsh sees it differently: fiscal dominance is an outgrowth of Federal Reserve actions that enabled profligate federal spending, led the Fed to stray from its monetary mission, and ultimately undermined Fed independence.

In other words: the problem of fiscal dominance is actually one of monetary policy run amok. 

The usual fiscal dominance story goes something like this. In normal times, a central bank should adjust its interest rate target as needed to deliver low and stable inflation. Under fiscal dominance, however, a profligate government forces the central bank’s hand. Rather than adjusting its interest rate target to maintain low and stable inflation, the central bank must accommodate government borrowing. Inflation inevitably rises because the central bank is effectively committed to monetizing government debt.

That, at least, is the conventional view. But Kevin Warsh, President Trump’s nominee to chair the Federal Reserve, has flipped the script.

In a talk delivered at the International Monetary Fund last year, Warsh said, “monetary dominance — where the central bank becomes the ultimate arbiter of fiscal policy — is the clearer and more present danger.” Rather than restraining fiscal excess, he argues, the modern Fed has enabled it. And, in doing so, it has undermined its own legitimacy.

Warsh on Monetary Dominance

Warsh traced the roots of today’s predicament to the 2008 financial crisis, when the Fed cut rates to zero, engaged in emergency lending, and pioneered large-scale asset purchases. He accepted that the Fed might use these tools to stabilize markets and prevent collapse in exigent circumstances. “But when panics subside,” Warsh said, “the Fed is duty-bound to retrace its steps.”

The problem, in his telling, is that the Fed never fully retreated. “Since the panic of 2008, central bank dominance has become a new feature of American governance,” Warsh observed. Crisis management hardened into a permanent practice, with the Fed maintaining a nearly $7 trillion balance sheet today. Warsh noted it was “nearly an order of magnitude larger” than when he joined the Fed Board back in 2006, and has made the Fed “the most important buyer of US Treasury debt — and other liabilities backed by the US government — since 2008.”

By suppressing borrowing costs, Warsh argued, monetary policy quietly subsidized fiscal expansion. “Fiscal policymakers…found it considerably easier appropriating money knowing that the government’s financing costs would be subsidized by the central bank,” he said.

The predictable result was more debt.

Three Key Warsh Statements

• Kevin Warsh argues the Fed has drifted far beyond its mandate, becoming a “general-purpose agency of government.”
• Rather than restraining fiscal excess, he argues, the modern Fed has enabled it. And, in doing so, it has undermined its own legitimacy.
• “Fiscal policymakers…found it considerably easier appropriating money knowing that the government’s financing costs would be subsidized by the central bank,”

Why did Trump Nominate Warsh?

• To do exactly what Trump wants and that is to become a general-purpose agency of government.
• Trump expects Warsh to undemine his own legitimacy.
• Trump expects Warsh to lower rates, financing government costs.

It’s quite the hoot for Warsh to be in this position. He volunteered to to be Trump’s puppet.

Strike that. He actively campaigned for it.