Reposting: Remembrance of Kevin Warsh Past

A very political possible Fed chair

OK, the betting markets say it’s a good time to repost something I wrote last April

For now, it seems as if Donald Trump will wait for Jerome Powell’s term to expire rather than firing him. But when Powell goes, Trump appears likely to appoint Kevin Warsh to the job. What do we know about Warsh?

The answer is, he’s an operator who says things that sound smart unless you pay attention. People who wonder whether he’s a monetary hawk or dove are missing the point: he’s political, against policies that help Democrats and for policies that help Republicans.

I thought it might be interesting for people to read what I wrote about him in June 2010, during the aftermath of the financial crisis. Reposted from my old blog:

The Conventional Superstition

June 2010

Calculated Risk points us to a speech by Kevin Warsh that strikes me as almost the perfect illustration of the predicament we’re in, in which policy is paralyzed by fear of invisible bond vigilantes. Warsh isn’t an especially bad example — but that’s the point: this is what Serious People sound like these days.

The bottom line of Warsh’s speech — although expressed indirectly — is that it’s time for fiscal austerity, even though the economy remains deeply depressed; and no, the Fed can’t offset the effects of fiscal contraction with more quantitative easing. In short, the responsible thing is just to accept 10 percent unemployment.

And why is this the responsible thing? On fiscal policy,

market forces are often more certain than promised fiscal spending multipliers.

Um, but those market forces are currently willing to lend money to the US government at an interest rate of 3.05 percent. But never mind:

unanticipated, nonlinear events can happen

So it’s these “unanticipated, nonlinear events” that are “more certain” than the direct effects of fiscal policy? I’m confused.

And on monetary policy,

The Fed’s institutional credibility is its most valuable asset, far more consequential to macroeconomic performance than its holdings of long-term Treasury securities or agency securities. That credibility could be meaningfully undermined if we were to take actions that were unlikely to yield clear and significant benefits.

OK, but why, exactly, does it help the Fed’s institutional credibility to do nothing to help a deeply depressed economy?

The point here is that Warsh’s argument basically rests on assertions not about what markets are saying now, but about presumed market reactions to policy. And these assertions about how markets will react are

(a) not based on any actual evidence
(b) actually assume that markets will behave irrationally

This goes for both fiscal and monetary policy. Again, right now the bond market doesn’t seem worried about US solvency. And rationally, stimulus spending shouldn’t change that view: with the long-term real interest rate well below 2 percent, current borrowing has only a trivial effect on the long-run state of the budget.

You may say that markets will see short-run austerity as a signal of our willingness to make long-run sacrifices; but why? What the United States needs to do in the long run, mainly controlling health care costs and increasing revenue, has nothing to do with the question of whether we have a second stimulus package.

On monetary policy: again, the large expansion of the Fed’s balance sheet so far doesn’t seem to have worried markets: right now, the 10-year TIPS spread is 1.9, showing no sign of exploding inflationary expectations. And for that matter, a rise in inflation expectations would actually be a good thing right now, encouraging more spending — unless you believe that markets will someone react badly, for reasons not specified, to the Fed’s impaired “credibility” defined as … well, I’m not sure what.

So what we’ve got here is an assertion that bad things will happen if you do certain things, without either any evidence to that effect or any explanation of why those things should happen. Yes, maybe bond markets will punish us if we don’t slash spending right now; also, maybe we’ll have bad luck if we step on cracks, or fail to turn aside when Basement Cat crosses our path. But why does this pass for judicious policy discussion?