The “regime change” that Kevin Warsh promised is on hold at the Federal Reserve.
On Wednesday, the central bank’s governing committee continued business as usual, voting to keep interest rates unchanged at between 3.5 and 3.75 percent. Conditions are not hunky-dory, however. Warsh, despite voting to maintain rates, openly admits that year-over-year inflation is still too high — hovering around 3 percent. How could he not?
That is why, in a rare rebuke, three out of twelve Fed officials dissented in favor of raising rates by a quarter-percentage point. Financial markets were also unnerved, as investors questioned the Fed’s willingness to rein in inflation.
In his stated objectives, Warsh is nothing but admirable. He believes that full employment must coexist with price stability, not be prioritized at its expense. The Fed, he says, should react to the economy, not the other way around. Warsh is also right to curtail forward guidance about the Fed’s next moves, leaving markets to rely on genuine economic signals. All of this is welcome restraint.
What is needed most from the Fed now, however, is action to reduce inflation to its 2 percent target. Warsh reaffirmed this commitment in his press conference, further staking the institution’s credibility on achieving it. What remains to be seen is whether he will be willing to do what it takes. If not a rate hike, then what? He is in no position to cut tariffs.
Recent energy shocks have contributed to a spike, but the Fed has not met its inflation target in over five years. The rate has bounced between 2.5 and 4 percent for the past three of those years. To tame the initial inflation surge, the Fed sprinted to raise interest rates and halted asset purchases. But this tightening ended in 2024, and central bankers have since eased monetary policy by cutting rates.
Warsh has advocated shrinking the Fed’s bloated balance sheet, which could drain excess reserves from the economy. As of this year, however, the balance sheet has resumed its growth. Other than asset sales, the only policy tool the Fed has left to control inflation is to raise interest rates. Warsh recently held the opposite position, arguing that the Fed should decrease rates based on speculative productivity growth that hasn’t yet materialized.
In the long run, inflation and the economy would be better off if Warsh gets his way on fundamental reforms, having the Fed defer more to organic market developments. Ideally, the Fed should adopt a rules-based approach to keep the supply and demand for money in equilibrium. Such a framework would force the Fed to tighten policy when too much money is chasing too few goods, anchoring inflation to economic growth. It would also foster the predictability that businesses need and markets crave.
Until then, the Fed’s policy decisions remain much too discretionary, yet their importance to the dollar’s value is just as great. Monetary policy has been too expansive for too long. Fed-watchers will continue to doubt the institution’s resolve if inflation persists with no rate hikes to tame it.