Fed Chairman Warsh faces an inflation credibility test: Analysis

Reliability is everything to Kevin Warsh. This week’s Congressional hearings showed how difficult it will be for the new Federal Reserve chairman to maintain this.

Warsh had few major lapses amid intense questioning from Democrats and supportive comments from Republicans in back-to-back days of testimony before the House and Senate on Tuesday and Wednesday. But while both sides fully agree that prices are still rising too quickly, the Fed chairman must quickly follow through on his promises to keep prices stable. Otherwise, he risks losing support both within the Fed and among the president’s traditional power base on Capitol Hill.

One of Warsh’s challenges is that he wants to rethink how the Fed measures inflation. Consumer and producer price indices, two important measures of prices, showed unexpected declines this week. While CPI decreased by 0.4% in June, PPI decreased by 0.3%.

“Any central bank would be happy to see the data going in the right direction,” Warsh said Wednesday. he said. “In my view, these are all flawed measures of the state of underlying inflation.”

The Iran war has increased gas prices in the United States, but Warsh said that’s not necessarily inflation, or at least not the kind the Fed can handle.

“There are specific price shocks at certain prices that we have no control over. But I don’t want to suggest that we have no control over inflation in the medium term. That’s our job,” Warsh said.

Warsh appointed a working group to answer his question about the nature of inflation, but that team would not produce results for months. The Fed will meet in two weeks to decide the course of interest rates, and voting officials appear divided on whether factors such as a boom in data center construction to support a growing artificial intelligence industry will start to boost generalized prices.

Fed Chairman Lisa Cook In a speech on Wednesday, he pointed to AI spending as a potential driver of inflation. It warned of “significant price increases for chips, other high-tech equipment, software and utilities.” Stating that this changed his general view on inflation, the official said that “inflation risks now outweigh employment risks.”

Warsh said the debate over AI spending was “one of those good family squabbles” at the Fed. His view was that supply would likely increase to catch up with demand. “I don’t think a single change in prices is necessarily inflationary because I think there is a supply response. That’s different from an external conflict and what it can do, which tends to reduce the supply side of the economy.”

It remains to be seen whether a separate task force on artificial intelligence will help resolve this debate. Some Republican senators praised the intellectual diversity of Warsh’s task force members, with the president mentioning one of them included “a team of competitors.”

But it’s not clear the task forces will oppose Warsh’s views. Members of Warsh’s AI task force are all extremely optimistic about AI. As Democratic senators pointed out Wednesday, there is no one in this group who will speak openly on behalf of workers.

Warsh channels a conservative economic tradition at the Fed. His monetary policy report He revived the practice of reporting to Congress on the size of the money supply. The Fed under former Chairman Jerome Powell thought information about the money supply was essentially irrelevant to inflation, but Warsh disagrees. He does not want to return to the period when the Fed targeted the size of the money supply when making policy decisions, but he believes that some monetary measures can provide useful information about inflation.

“I have an old-fashioned view that monetary policy has something to do with money,” Warsh said.

The risk for Warsh is that unless inflation begins to decline significantly soon, all these decisions will be closely scrutinized for signs that ideology has trumped clear analysis. Warsh refrained from making any commitments on interest rates, but markets now predominantly expect the Fed to raise interest rates by the end of the year. Warsh needs to be on the right side of this decision.

If rates rise because Warsh loses the debate on AI spending to other members of his committee, then the president’s credibility will suffer. A worse outcome would be if Warsh wins the debate and keeps rates steady or low, only to see inflation accelerate again.

This kind of loss of credibility would be a problem that even the best task force could not solve.