Han Dieperink: A hawk or a dove?
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
The US Senate has approved the appointment of Kevin Warsh as Chair of the Federal Reserve. But who exactly is Kevin Warsh, and what can we expect from him?
Kevin Warsh is no newcomer. He studied at Stanford University and Harvard Law School, and served as a member of the Federal Reserve Board between 2006 and 2011. During that period, he lived through the major financial crisis of 2008. He therefore knows what it means to have to make decisions in difficult times. After leaving the Fed, Warsh returned to Stanford, where he taught and conducted research. He also worked with well-known investors, including at the office of hedge fund manager Stanley Druckenmiller. In 2017, Warsh had almost become chairman of the Fed, but Trump opted for Jerome Powell instead. In hindsight, Trump called that a mistake.
Jerome Powell has regularly clashed with Trump in recent years. The president felt he was lowering interest rates too slowly. Trump voiced open criticism and the Department of Justice even launched a criminal investigation into Powell. That investigation has since been dropped, clearing the way for Warsh’s appointment.
Hawk or dove?
In the world of central banks, policymakers are often characterised as ‘hawks’ or ‘doves’. A hawk prioritises low inflation and price stability, and is more inclined to raise or keep interest rates high, even if this slows growth. A dove takes a different view and prioritises economic growth and employment, even if this entails slightly higher inflation.
Warsh was long known as a hawk. He warned against excessive money creation and was critical of the Fed’s asset purchase programme. But in the run-up to his appointment, his tone shifted. He spoke more often of lower interest rates and seemed to be aligning himself more closely with Trump’s wishes. Critics call his changing stance opportunistic and fear he will be overly influenced by political pressure. Supporters argue that the world has changed due to developments such as artificial intelligence and deglobalisation, and that a different policy is simply necessary. Only once Warsh is actually at the helm will it become clear whether he positions himself as a hawk, a dove, or something in between.
What does Warsh want to change?
During his Senate hearing, Warsh spoke of various reforms. He wants to overhaul the Fed’s inflation model and look more closely at which prices are rising structurally and which are merely changing temporarily due to geopolitical tensions or seasonal effects. He also wants to reduce the Fed’s balance sheet. During and after the financial crisis, the Fed purchased huge quantities of government bonds. At its peak, the Fed held nearly nine trillion dollars in debt. Warsh believes this is too much and wants the Fed to withdraw from such activities. He also advocates for better communication and is critical of the way the Fed uses its so-called ‘forward guidance’.
What does this mean for investors?
For investors, the appointment of a new Fed chair is always a significant moment. After all, interest rates have a direct impact on share prices, bonds, mortgages and exchange rates. The key question is whether Warsh can maintain the Fed’s credibility. Financial markets rely on the central bank operating independently.
That trust cannot be taken for granted. In the 1970s, Fed Chairman Arthur Burns, under pressure from President Nixon, was persuaded to adopt an overly accommodative interest rate policy. The result was a decade of high inflation. It was only when Paul Volcker raised interest rates to 20% in 1979 that inflation was brought under control. That intervention was extremely painful, but it laid the foundations for the economic stability of the 1980s and 1990s.
The lesson is clear: a central bank that relinquishes its independence ultimately pays a high price for doing so. If investors get the impression that the Fed is following political orders rather than economic data, they will demand higher interest rates to compensate for the extra risk. That would be bad news for the US government, which, with a national debt of over $36 trillion, is under enormous financing pressure.
The alternative: artificial intelligence
The history of central banking is essentially a history of human error. From the overly loose monetary policy under Arthur Burns to the belated response to the housing bubble in 2007. Time and again, it has become apparent that central bankers are vulnerable to political pressure, groupthink and misjudgements. Perhaps the best alternative is therefore an AI solution. An algorithm could ensure that the policy rate is always a quarter of a percentage point above the natural rate. In this way, companies that do not grow faster than the economy will be unable to finance themselves, and the total amount of debt will remain limited. Companies that do grow faster will benefit from the lower interest rates, thereby stimulating innovation.
Whereas human central bankers repeatedly succumb to the temptation of short-term solutions – whether under pressure from a president or out of fear of a recession – an algorithm, devoid of emotion and political agenda, could consistently maintain the correct interest rate level. It is a radical idea, but given the long history of human errors in monetary policy, perhaps less far-fetched than it seems at first glance.