Kevin Warsh was a Fed Governor during the financials crisis and thanks to rules that release transcripts six years after the meetings, we can see exactly what he argued for and why.
They highlight an overly-hawkish plicymaker that was flat-out wrong about the inflation risks. It’s also in stark contrast to his recent turn towards being an unabashed dove, something that seems politically expedient given that he has lobbied for the Fed Chair job for at least 9 years.
Warsh was an FOMC governor from 2006 to 2011. Here are some revealing comments.
FOMC transcript, Jan 30–31, 2007:
“The trends appeared supportive of strong, balanced economic growth for 2007… although inflation expectations are well anchored… I remain much more concerned about inflation prospects than about growth.”
Inflation receded that year and it ended in recession.
Same meeting:
“If the housing situation is beginning to stabilize, I find it hard to believe that broader anxiety about it will affect business spending or the consumer as some of these scenarios contemplate.”
Housing wasn’t beginning to stabilize, at all.
FOMC transcript, Mar 20–21, 2007
“Let me say at the outset that I believe the moderate-growth scenario is the most likely for 2007.”
Three months later even as cracks were more-noticible in the financial system, Warsh was still off the mark.
FOMC transcript, Apr 29–30, 2008
“I worry that we may be resting too much on our laurels…unwilling to take the actions necessary to support and sustain [our] credibility. As I have said before in this group, we must not wait until [inflation] expectations have broken out because by then it will be too late.”
There was a lively debate around this time because commodity prices were rising but the real economy was stumbling and the Fed cut by 25 bps to 2.00%. Dallas Fed President Richard Fisher and Philly Fed President Charles Plosser dissented at this meeting to hold but Warsh fell in line and voted to cut. He argued at the time that he wasn’t optimistic about the economy by that time but he also argued for statement language that would indicate a pause at the subsequent meeting.
“I take comfort in believing that the language in the minutes and the remarks that we all offer between now and the next time we meet will suggest not that this is a cut with a dovish pause but that this is a cut with an expectation of holding after our actions today,” he said.
FOMC transcript, Jun 24–25, 2008
“What I think most likely is that…before we have to begin a posture of removing policy accommodation. …Policy remains more accommodative than we can allow it to be for too long, I will support [option] B and think that we have to remain very open-minded, very nimble, in our task of removing policy accommodation.”
Context: By mid-2008, as headline inflation spiked (oil was $140/barrel), Warsh leaned toward tightening policy “soon”. In this quote he endorses holding rates unchanged (option B) with an eye toward starting to hike rates relatively soon, arguing the Fed’s 2% federal funds rate was too stimulative.
FOMC transcript, Oct 28-29, 2008
“We don’t want to find ourselves in a corner come December or come a couple of brutal days in the
markets where we feel compelled to continue to act and make 50 basis point moves unless and until we know where we want to end up on this. So I’m sympathetic to that point of view.”
In October 2008, in the teeth of the financial crisis, he was very pessimistic about the economy but still argued against easing below 1.00% because it would hurt Fed crdibility.
FOMC transcript, Dec 15–16, 2008
“On balance I’m inclined to believe that the macroeconomic benefits of pushing the envelope to get to zero may be outweighed, particularly now, by additional financial market problems… I take very seriously the risk that reducing the fed funds rate to zero could further degrade the functioning of financial markets and do so at a very inauspicious moment.”
At the height of the crisis, as the Fed debated cutting the policy rate from 1% to effectively 0%, Warsh voiced caution. He worried that rushing to a zero rate could “degrade” market functioning. The Fed cut to 0.00-0.25% and his fears proved overblown
In November 2010, Warsh wrote in an op-ed that fiscal and monetary policy were too easy. Ironically, he also argumed that “the creep of trade protectionism is anathema to pro-growth policies”.
FOMC transcript, Jan 25–26, 2011
“Second, as I will discuss in more detail, inflation – it’s getting hard and harder, in my view, to deny inflation risks, if not real inflation problems, among many of our trading partners, and that’s likely to lessen the flexibility that monetary policy has…”
Ultimately, this was the argument that broke Warsh, along with QE2. He said the Fed was out of options but later that year we got Operation Twist and in 2012, QE3. Inflation ran below the Fed’s target for the remainder of the decade. If anything, the pandemic proved that the Fed would have been wise to embark in stronger QE sooner, it also showed the fiscal policy was far from overly stretched.
Warsh resigned in February.
This article was written by Adam Button at investinglive.com.