Kevin Warsh for Fed chair?

There is increasing chatter that Kevin Warsh is being seriously considered for Fed chair.  He would not be my first choice, for several reasons:

1.  He is viewed as a well rounded figure, with some knowledge of both monetary policy and the financial system.  I’d prefer someone who has great expertise on monetary policy, even if they knew little about anything else.

2.  He was spectacularly wrong about policy during the Great Recession.  Here is Business Insider:

Back in 2009-2011, while still at the Fed, Warsh was keenly worried about inflation at a time when consumer price growth was actually deeply undershooting the central bank’s 2% target and unemployment remained very high. His concerns, since reiterated in the occasional opinion piece, have proven deeply misguided since the Fed continues to undershoot its inflation goal to this day. Indeed, bond investors have palpable doubts about the Fed’s plans to continue raising interest rates next year and in 2019.

And here is Politico:

Jordan Haedtler of the progressive group Fed Up, which advocates lower interest rates and more diversity at the central bank, doesn’t see Warsh’s Wall Street ties as a positive.

“He was tasked by Bernanke with being the emissary to his former employer and other major Wall Street firms, so his independence from the financial sector is just as questionable as the Trump administration as a whole,” he said.

Haedtler also argued that Warsh was “spectacularly wrong during the lead-up to the crisis, during the crisis and following the crisis.” He cited a March 2007 speech in which Warsh praised the proliferation of new financial instruments, one of the major factors leading to the crisis.

Can we now be sure that Warsh was wrong about monetary policy during the Great Recession?  I think so, but I’d also like to briefly discuss the implications of the other view, that we can’t be sure he was wrong.  If that were true, then monetary economics would be useless. There would be no core of knowledge worth teaching to our students.  The loony right wing critics of the Fed would be correct; it would be a bunch of priests in robes incanting a lot of mystical mumbo jumbo, with no connection to anything real.  Indeed it’s now so obvious that money was too tight during the Great Recession that anyone still denying that claim basically loses all credibility.

Imagine that we actually didn’t know that Warsh was wrong.  Now imagine a cynical student who likes to shoot his mouth, sitting in the front row of a college monetary economics class.  The instructor starts teaching, and the student immediately shoots his hand up in the air.  “How do we know that’s true.”  “Prove it.”  “I don’t believe you.”   “You say the Fed pursues a dual mandate, but then how come even famous monetary economists can’t agree that money was too tight during the Great Recession, when both employment and inflation were far below target, and when the inflation they warned about never showed up, even years later when unemployment fell to 4.3%”.  “If you guys can’t even agree on that, then how can you claim to know anything.”

I don’t think we could criticize that annoying student.  Who’s to say he’s wrong? Why should he accept anything he’s being taught as being true, if even the leaders of the profession can’t agree on its most basic principles?

And BTW, I’d say the same thing about microeconomics.  If we as a profession can’t agree that “price gouging” is a good thing, which should not be outlawed, then how can microeconomists claim to know anything.  And yet a recent post by David Henderson discussed a poll which showed that 8% of leading economists actually hold those deeply unscientific views. (And lots more were uncertain.) Opposing price gouging is not like denying global warming, it’s far worse.  It’s like creationism.  At least with global warming there is some doubt.  (I happen to agree with the scientific consensus.)  But if economists are wrong about price gouging, then you might as well put all EC101 textbooks into a big bonfire.  Greg Mankiw’s (excellent) textbook is probably about 750 pages long, but the basic punch line of much of what he says can be boiled down to something to the effect that, “price gouging is not only good, it’s the whole point of a market economy.” (My words, not his.)  If Mankiw is wrong about that, then he’s wrong about almost everything.

And Madura’s policies in Venezuela would be wonderful.



23 Responses to “Kevin Warsh for Fed chair?”

  1. Gravatar of John Hall John Hall
    20. September 2017 at 09:54

    If Kevin Warsh is nominated as Fed chair, I would be tempted to go short rates.

  2. Gravatar of Garrett Garrett
    20. September 2017 at 11:05

    I remember being that annoying student. At least I waited until office hours to bother you.

  3. Gravatar of Effem Effem
    20. September 2017 at 11:23

    On price gouging, it depends entirely on supply dynamics. There is no simple “good” vs “bad” answer.

  4. Gravatar of Kevin Erdmann Kevin Erdmann
    20. September 2017 at 11:23

    Maybe this is slightly off topic, but it’s a mystery to me, regarding the financial crisis and “the proliferation of new financial instruments”. The vulgar explanation of the boom and bust is that easy money led to a surplus of short-term risk taking, which imploded when expectations fell back to earth. But, the weird thing is that the entire CDO boom happened when the Fed had raised short term rates and the yield curve was inverted. The crisis was set off in large part by investment banks who couldn’t roll over short term repo financing. The mystery is, why was there so much exposure to short term repo markets when you could get long term financing at similar rates?

    It seems to me that the misdirected focus on supposedly loose monetary policy before 2006 and the sloppy summation of the price bubble and the following CDO boom into one single event called “the bubble” that created a bust which the financial sector is culpable for, has led to a lack of curiosity about this mystery.

    The double irony about Warsh’s comment is that those innovative new financial instruments were already a response to disruptive expectations, since the demand for those instruments was the result of a rush to safe securities which couldn’t find an investment outlet because already expectations were so low that few were willing to take a large new position in home equity.

    By late 2006 and 2007, there were so few willing equity holders that the synthetic CDOs were constructed with no equity holders at all, just speculators who were willing to make coupon payments to investors in anticipation of a financial collapse that would give them windfall gains.

  5. Gravatar of ssumner ssumner
    20. September 2017 at 12:38

    Garrett, You had good questions.

    Effem, No, it doesn’t depend at all on supply dynamics.

  6. Gravatar of Benjamin Cole Benjamin Cole
    20. September 2017 at 16:56

    That’s the great thing about macroeconomics. No one is ever wrong!

  7. Gravatar of Major.Freedom Major.Freedom
    20. September 2017 at 17:04

    Hugo Chavez said Socialism can work, there just needs to be the right people in charge


  8. Gravatar of Bonnie Bonnie
    20. September 2017 at 17:47

    At the September 16, 2008 FOMC meeting, Warsh, after three exhausting paragraphs about how he couldn’t tell what is going on, basically said ‘we are not going to act’ until they do know more.

    I suppose that one could say Warsh was wrong because doing nothing incurred dire consequences when doing something may not have. Perhaps you have a better perspective on his statement in the transcript, but I can’t make heads or tails of what he is saying there, as if to be a lot of fluff before he decides to vote the consensus. For the sake of argument though, it appears that “clueless” is a better description of it than wrong.


    Warsh’s statement begins on page 59.

  9. Gravatar of LK Beland LK Beland
    21. September 2017 at 05:34

    Ironically, David Henderson has a strong willingness to peddle unscientific–or at least highly misleading–views about climate change.

  10. Gravatar of LK Beland LK Beland
    21. September 2017 at 05:40

    For the record, I share many of David Henderson’s views. However, his actions and writings in regards to climate change seem deeply wrong, imho.

  11. Gravatar of Todd Ramsey Todd Ramsey
    21. September 2017 at 05:52

    This is definitely off topic.

    Larry Summers in “Conversations with Tyler” said that his “instinct” for appropriate Fed policy is nominal GDP targeting.

    Ten years ago, no mainstream economists were espousing NGDP targeting.

    You are making a large and important difference in the world! Keep up the good work!

  12. Gravatar of Andrew Andrew
    21. September 2017 at 07:52

    Todd, it is worth noting that Scott was fairly massively opposed to having Larry as Fed chair when his name was floating around.

    He could have had NGDP targeting but ended up with Yellen and years of inflation undershooting.

  13. Gravatar of Majromax Majromax
    21. September 2017 at 08:33

    Well, just what is meant by “price gouging?” If we’re talking about temporary increases in price for an existing, already-produced stock, then price gouging is a wealth transfer from customers to the owner of that stock.

    This is Pareto-optimal, in that with a market mechanism we end up with the (stuff) being owned by people who value it the most of their available options. However, we know from the fundamental theorems of welfare economics that lump-sum wealth transfers just move us from one optimum to another.

    So we could make price gouging illegal yet still have an optimum by purchasing the business owner’s entire stock at its pre-disaster rate (which does not affect incentives for future production or purchase), auctioning the stock to the highest bidder, and distributing the profits as a per-capita transfer. Those who want (stuff) the most still obtain it, the business owner is not forced to operate at a loss, and everyone else receives compensation for forgoing the purchase.

    Of course, this narrow definition of “price gouging” probably does not reflect a common understanding of the practice – certainly not the Venezuelan definition of “business should restock and operate at an ongoing loss.”

  14. Gravatar of LK Beland LK Beland
    21. September 2017 at 09:38

    Janet Yellen and Larry Summers were both excellent picks as Fed Chair.

    I would argue that given her talent as a consensus builder and the fact that she isn’t as close to the Democrats and Clinton/Obama than Summers, Yellen has a better chance of being re-appointed by Trump than Summers. Given that the other option seems to be Warsh, Yellen was the right choice, in retrospect.

  15. Gravatar of Tommy Dorsett Tommy Dorsett
    21. September 2017 at 09:39

    If Warsh becomes Fed Chair, the open Board Seats will probably go toward a hawkish contingent and the Fed will likely invert the yield curve by mid-to-late 2018, arguing that “it’s different this time.” It won’t be. But it will likely all be done under the misleading banner of “financial stability”, the new rallying cry of hard money zealots who now want the Fed to pop perceived bubbles because the inflation they falsely predicted never showed up. Save the patient by killing it. Refreshing.

  16. Gravatar of Christian List Christian List
    21. September 2017 at 14:19

    If we as a profession can’t agree that “price gouging” is a good thing, which should not be outlawed, then how can microeconomists claim to know anything. 

    This is a highly political issue (like organ donations for example). Scientists aren’t neutral, they all have their political opinions. Not to mention that it’s very politically incorrect to be pro price gouging.

    In this case I even understand the partial scientists a bit. Firstly huge parts of the question are completely political. It’s basically a political question. („Connecticut should pass its Senate Bill 60”, hello?!). Secondly the phrasing is not really scientific but highly subjective. Why would you write “unconscionably excessive” for example? What does this even mean? Price gauging is the opposite of unconscionably excessive pricing, it’s completely reasonable pricing.

    Maybe a few economists would vote differently, if the phrasing were less political and less subjective. On the other hand I doubt that too many economists would change their vote because the main issue remains: It’s still very politically incorrect to be pro price gouging.

  17. Gravatar of Christian List Christian List
    21. September 2017 at 14:44

    Maybe Trump should just keep Yellen, I guess she didn’t make any major mistakes so far. On the other hand she seems to be conservative (in the sense of being very cautious about change and innovation), so it’s questionable that she would improvise and innovate if innovations were needed.

  18. Gravatar of Matthew Waters Matthew Waters
    21. September 2017 at 15:30

    I really have a hard time understanding how people such as Warsh have such strong “low rate are bad” convictions.

    It’s VERY common among bankers to give extremely surface-level arguments about the evils of low rates. It’s more understandable for bankers, who have a lot on their plate and don’t see the whole picture. Even John Kasich, who I have a lot of respect for, gave horrible reasoning about how low rates were slowing the recovery.

    But for somebody like Warsh, who has been around the Fed, how does he not realize the inherent issue with the reasoning? What does he think should happen in lieu of “unnatural” low rates? The Fed should never cut interest rates below, say, 3% no matter the deflation or unemployment?

    In practice, in Europe and Japan these kind of VSP’s ironically got lower rates in the end. By being more quick to raise rates actually lowers long-term rates. I can see why this is hard to understand for laypeople, but it’s not SO hard that a Fed board member shouldn’t figure it out.

  19. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2017 at 23:15

    Matthew Waters-

    Oh, it gets even sillier.

    As Milton Friedman noted, you do not get nominally low rates with easy central bank money, and you will not get even low real rates from easy money for long.

    US Treasuries are largely purchased by sophisticated institutional investors. Tightening money now will lead to less growth and lower interest rates, and perhaps lower inflation.

    Here is another funny one: It is gospel in the tight-money crowd that low interest rates lead to ruin, as borrowers and lenders go bananas. The rational man, and EMH die.

    Investors, lenders and borrowers become irrational, changing their pinstripes for bozo outfits when rates are low.

    But tight money will lead to lower interest rates—and then the bozos take over?

  20. Gravatar of JL JL
    22. September 2017 at 00:53

    Ahh price gouging, where economics and utilitarianism conflict.

    Consider a situation where there are only two seats left on the last plane leaving a disaster area. A young couple and their two children could board this plane, the kids sitting on the parents lap.

    Or an older couple with no dependents could board the plane.

    Looking at it from a moral and utilitarian perspective, it would make sense to save the younger family.
    Indeed, if they were related, most people would choose to save their children and grandchildren.

    But if the older couple has more financial means and if we allow price gouging, we might get a different outcome.

    Of course I understand that if we allow prices to rise, the market will allocate more resources (e.g. send more planes). But even so, there is a limited number of planes that can be sent on a short notice and processed by airports.
    Once the elastic limits of supply has been reached, any further increase in price will not increase supply and will merely serve to increase profit on a limited supply, to the detriment of vulnerable buyers.

    Hence, I do see a utilitarian case to put some caps on price gouging in emergency situations.

  21. Gravatar of ssumner ssumner
    22. September 2017 at 10:26

    Thanks Todd.

    Andrew, I very much doubt Summers would have implemented NGDP targeting. He is on record as opposing policy rules and favoring discretion.

    Majromax, An auction would still be viewed as price gouging.

    JL, That’s not a reason to ban price gouging, you are making the case for income redistribution.

  22. Gravatar of Michael Byrnes Michael Byrnes
    23. September 2017 at 06:47

    I remember reading Hank Paulson’s (Bush’s Sec Treas during the crisis) book. It’s been years and I forgot a lot of specific detail, but one memory that sticks with me is that he wrote a lot (and positively) about 2 younger guys he worked with during the crisis: Kevin Warsh and Neel Kashkari.

    It’s unfortunate that of the two, Warsh is the one being talked about as the next Fed Chair.

  23. Gravatar of Alka Talwar Alka Talwar
    25. September 2017 at 23:43

    Perhaps Trump should simply keep Yellen, I figure she didn’t commit any significant errors up until now. Then again she is by all accounts preservationist (in the feeling of being extremely wary about change and development), so it’s sketchy that she would extemporize and enhance if advancements were required.

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