Credibility is everything for Kevin Warsh. Congressional hearings this week showed how hard it will be for the new Federal Reserve chairman to keep it.
Warsh had few, if any, major slip-ups amid intense questioning from Democrats — and supportive commentary from Republicans — in back-to-back days of testimony before the House and Senate on Tuesday and Wednesday. But with both parties in full agreement that prices are still rising too fast, the Fed chairman needs to quickly deliver on his promises to keep prices stable. If not, he risks losing support both within the Fed and in the chairman’s traditional power base on Capitol Hill.
Part of Warsh’s challenge is that he wants to rethink how the Fed measures inflation itself. Two important measures of prices — the consumer and producer price indexes — showed unexpected declines this week. CPI fell by 0.4% in June, while PPI fell 0.3%.
“Any central bank would be happy to have the data going in the right direction,” Warsh said Wednesday. “My view is these are all imperfect measures of the state of underlying inflation.”
The Iran war has raised gas prices in the U.S., but Warsh said that isn’t necessarily inflation, or at least not the kind the Fed can deal with.
“Particular price shocks happen to particular prices that we don’t have control over. But I don’t want to suggest we don’t have control over inflation in the medium term. That’s our job,” Warsh said.
Warsh has appointed a task force to help answer the question he’s asking about the nature of inflation, but it won’t deliver results for months. The Fed will meet in two weeks to decide on the course for interest rates, and its voting officials appear divided on whether factors such as the boom in data-center construction to support a growing artificial intelligence industry are starting to raise generalized prices.
Fed Governor Lisa Cook in a speech Wednesday pointed to AI spending as a potential driver of inflation. She warned of “significant price increases for chips, other high-tech equipment, software, and utilities.” That is changing her overall view of inflation, she said, “with inflation risks now outweighing employment risks.”
The debate over AI spending “is one of the good family fights” at the Fed, Warsh said. His view was that supply would likely grow to catch up with demand. “I don’t view one change in prices as necessarily being inflationary because I think there’s a supply response. In that way, this is different from a foreign conflict and what it might do, which tends to reduce the supply side of the economy.”
Whether a separate task force on AI will help resolve that debate remains to be seen. Some Republican senators praised the intellectual diversity of the members of Warsh’s task forces, and the chairman spoke of one as containing a “team of rivals.”
But it isn’t a given that the task forces will challenge Warsh’s views. The members of Warsh’s AI task force are all hugely bullish on AI. As Democratic senators pointed out Wednesday, there is no one in that group who will obviously speak for labor.
Warsh is channeling a conservative economic tradition at the Fed. His monetary policy report to Congress resurrected a practice of reporting on the size of the money supply. The Fed under former Chair Jerome Powell considered information about the money supply to be essentially irrelevant to inflation, but Warsh disagrees. He doesn’t want to return to the era when the Fed targeted the size of the money supply in making policy decisions, but he believes certain monetary measures can give useful information about inflation.
“I have this old-fashioned view that monetary policy has something to do with money,” Warsh said.
The risk for Warsh is if inflation doesn’t soon start declining in a substantive way, all of these decisions will be closely scrutinized for signs that ideology overtook clear-headed analysis. Warsh has avoided making any commitments where he will take interest rates, but markets now overwhelmingly expect the Fed to raise interest rates by the end of the year. Warsh needs to get on the right side of that decision.
If rates go up because Warsh loses the argument about AI spending to the other members of his committee, then the chair’s credibility will suffer. A worse result would be for Warsh to win the argument and keep rates flat or down, only to see inflation reaccelerate.
That kind of loss of credibility would be a problem even the best task force can’t fix.