Kevin Warsh, recently confirmed as a Federal Reserve Board Governor and positioned to become the next Chair, has long been a vocal critic of the central bank’s recent performance. He argues that the Fed must undergo a fundamental “regime change” to restore credibility, improve policy effectiveness, and better serve the American economy after what he describes as major policy errors during the post-COVID inflation surge.
Acknowledging Past Mistakes and the Need for Overhaul
Warsh has repeatedly criticized the Fed’s handling of monetary policy in 2021–2022, calling it one of the “biggest macroeconomic mistakes” in decades. He believes the central bank’s slow response to rising inflation imposed lasting costs on American families. In confirmation hearings and public statements, he emphasized the need for new frameworks, tools, and communications strategies rather than continuity with past approaches.
“We need a new framework, new tools, and… new communications,” Warsh has stated, signaling a break from recent practices.
Proposed Changes to Monetary Policy and Inflation Targeting
A centerpiece of Warsh’s vision is overhauling the Fed’s inflation framework. He has questioned reliance on traditional measures like the core Personal Consumption Expenditures (PCE) index and advocated for alternatives, such as trimmed averages that remove outlier data for a clearer view of underlying trends.
Warsh rejects the idea that inflation primarily results from an economy growing “too much” or workers being paid “too much.” Instead, he calls for re-examining the drivers of inflation and incorporating new data tools, potentially including insights from technological advancements like artificial intelligence (AI). He has suggested AI could drive significant productivity gains, helping restrain inflation and creating room for looser monetary policy over time.
Warsh notes sharp rises in the monetary base, up 60% post-pandemic, alongside M2 growth up around 36% in certain periods, with cumulative inflation lagging but still elevated as a result. He sees sustained high levels of money in circulation as keeping inflationary pressures alive.
Warsh’s Views on Fed Market Participation and Balance Sheet Reduction
A core element of Warsh’s agenda is shrinking the Fed’s massive balance sheet, currently around $6.7 trillion. He argues that sustained large-scale asset purchases distort financial markets, suppress yields artificially, blur the lines between monetary and fiscal policy, and provide outsized benefits to asset owners and large institutions at the expense of broader society.
Warsh has emphasized that the Fed’s footprint in markets should be minimized in normal times. He favors using the federal funds rate as the primary tool because it affects the entire economy more democratically, whereas balance sheet policies tend to flow disproportionately to financial markets and wealthier households.
He supports gradual quantitative tightening (QT) or passive runoff of assets, with particular attention to reducing holdings of mortgage-backed securities (MBS) and long-term Treasuries. Any reductions would proceed slowly and transparently to avoid market disruptions, acknowledging that building up the balance sheet took years and unwinding it requires patience.
Warsh has signaled that QE should be reserved strictly for emergency situations, not normalized as a regular policy tool. This approach aims to reduce excess liquidity, tighten financial conditions where appropriate, and potentially create room for lower short-term interest rates without relying on asset purchases
Scarce vs. Abundant/Ample Reserves
Warsh has not explicitly called for a full return to a pre-2008 “scarce reserves” system. Instead, he strongly advocates for a meaningfully smaller Federal Reserve balance sheet overall, which would naturally lead to lower (but still ample) levels of reserves compared to recent abundant conditions, while preserving effective monetary policy implementation.
Reforming Fed Communications and Decision-Making
Warsh believes Fed officials communicate too frequently and make overly definitive predictions about future policy, which can confuse markets and undermine credibility. He advocates for more restrained, less forward-guidance-heavy communications, potentially returning to a more traditional, opaque style of central banking, which was more the norm pre-2008 financial crisis.
He has also called for “messier meetings” on the Federal Open Market Committee (FOMC), encouraging a diversity of views and robust internal debate rather than consensus-driven uniformity.
Outlook on Interest Rates and Independence
While Warsh has signaled openness to rate cuts, particularly if AI boosts productivity, he is viewed as having hawkish tendencies from his earlier tenure as a Fed Governor (2006–2011). He has pledged to maintain Fed independence and base decisions on data rather than political pressure.
What This Means for the Economy and Markets
Warsh’s “regime change” agenda aims to make the Fed more agile, data-driven, and focused on long-term stability. Potential impacts include:
- A smaller Fed balance sheet over time.
- Evolving approaches to measuring and targeting inflation.
- Reduced reliance on extraordinary interventions.
- Clearer boundaries for Fed actions to preserve independence.
As Warsh assumes leadership amid ongoing inflation challenges and economic uncertainties, his reforms could reshape U.S. monetary policy for years to come. Markets will closely watch their first FOMC meetings for signals on the pace and direction of these changes. How many of these policy changes are put into action remains to be seen. It’s important to remember that the Federal Reserve’s committee structure limits how quickly any chair can enact sweeping policy changes. Warsh could meaningfully influence the tone, communication framework, and strategic direction of the Fed, even though monetary policy decisions remain committee based.
However, the notion of returning to a period of a smaller Fed balance sheet, and more of an emphasis and acknowledgement on the M2 money supplies impact and role in inflation would be a refreshing change from the recent Fed regimes of the last 25 years that barely address the M2 money supply in their Fed minutes. A clear stance on returning to a scarce reserves policy would be even more refreshing.
About the Author
Joseph M. Favorito, CFP® is a Certified Financial Planner® as well as the founder and managing partner at Landmark Wealth Management, LLC, a fee-only SEC registered investment advisory firm. He specializes in helping individuals and families develop comprehensive financial strategies to achieve their long-term goals.