Warsh criticizes the Fed’s shifting definition of inflation and questions the last half-point cut as unwarranted.
On CNBC Squawk Box, former Fed governor from 2006 to 2011 blasts the Fed in multiple ways.
Squawk Box Rebecca Quick: What do you mean when you say this [the 50 basis point rate cut] goes against what the Fed has been saying up to this point?
Kevin Warsh: They’ve had different theories Becky about the causes of inflation, the measures they use. People in the financial markets and the media have tried to follow those.
Warsh on Changing Preferred Measure of Inflation
- A few years ago they said they were for flexible average inflation targeting. So when inflation was at 1.7 percent they said they would get it a little higher, balanced around 2. They seem to have gotten rid of that idea without replacing it.
- Then they said for a long time what really matters is core PCE [the Personal Consumption Expenditures price index]. That’s what we should focus on. But it’s now running at around 2.7 percent, nowhere near their 2 percent range.
- About a year ago they said the best measure of inflation is a new category. They said it was core services excluding housing. Well, that’s in the fours [4 percent range].
- Previously, Janet Yellen said what really matters is wages. And we need wages to run at 3 percent which is consistent with inflation running around 2 percent. Well wages are running around 4.
- They don’t seem to have a serious theory of inflation that’s theoretical and empirical. It’s not obvious they acknowledge what their role is in prices. Instead it has something to do with wars and pandemics. [Actually, it’s obvious they refuse to admit their role in the process].
- Where fiscal policy is irresponsible, the central bank needs to be very clear about its reaction function, be clear about its goals, and not look like it’s lurching because that’s what put us in the mess we have.
Rebecca Quick tried to nail down Warsh on improvements in inflation, a dual mandate, and changing data.
Warsh replied: It’s a fair point. What you are really saying is they claim they are data dependent. And when times change they should change. Of course that’s right. The data, since the early part of summer has gotten better. The economy has gotten stronger. [Mish comment – assuming you believe the data, which supposedly the Fed does, or they should say so]. The broad sense [not mine] is the economy is in better shape. If that’s all true, maybe they are not data dependent.
Warsh on politics: I do not want to be the person accusing them of politics. [But he’s doing that anyway with much more below to come]. That’s not the central bank I know. But when you don’t have a theory and follow it, it’s easy to get that accusation, and it’s harder for me to defend them.
Should the Fed Influence Politicians?
Squawk Box Co-Host Joe Kernen: Should the Fed Influence Politicians? With Becky quick adding “and how complicated is that?”
Warsh: When they kept interest rates near zero, for a decade, and did Quantitative Easing where the central bank was buying the bonds of the Treasury Department in a crisis, and decided to make that more or less a permanent feature, it is the Fed that wandered into politics on a permanent basis. In a period of free money, it was a clear sign to Congress, you can spend all the money you want. So they did. …. Over the course of the last few years, Congress with relatively full employment, added 5 trillion dollars in deficits. This level of debt is dangerous to the economy.
Fed Uncertainty Principle
My favorite post ever is the Fed Uncertainty Principle. I wrote that on April 3, 2008, before the collapse of Lehman.
Corollary #1, #2, and #3 are the spotlights today, based on the statements of Warsh.
Here are the key snips.
Does the Fed Follows the Market?
Most think the Fed follows market expectations.
However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn’t the market to blame if the Fed is simply following market expectations?
This is a very interesting theoretical question. While it’s true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.
Fed Uncertainty Principle: The fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.
Corollary Number One: The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.
Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three: Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
The Fed has blown two major asset bubbles, never saw recession, and wanted to make up for lack of prior inflation when it does not even know what inflation in.
Now they give forward guidance on their thinking and all the banks front run it, which partially explains the collapse of Silicon Valley Bank.
Fed “Playing With Fire” Take Two, Who Starts the Business Cycle?
The discussion by Warsh is also a perfect follow-up to a Mises video and and my comments to the video Fed “Playing With Fire” Take Two, Who Starts the Business Cycle?
The Fed does not control fiscal policy but the Fed certainly enables fiscal policy by monetizing the debt. Massive QE operations create economic bubbles.
The Fed was not responsible for the unprecedented fiscal stimulus in Covid, but it was responsible to understand the impact.
The Fed’s monetary response on top of a massive and unwarranted fiscal response was one of the worst errors in Fed history.
Like Mises, I would like to End the Fed. The question is how.
Please click on the above link for a discussion of how and the risks involved.