New Fed chairmanship intensifies debate over independence, inflation shocks, and the fragility of the global financial regime
In nation-states, most institutions of authority meant to maintain a system of checks and balances are made aware of their limits at one point or another. Across parliamentary and presidential systems alike, when the executive — or, in some cases, the legislature — has made up its mind, there is little that an institution can do other than go down fighting. Yet, even in barely democratic regimes, the closest an institution comes to defying this reality is the central bank.
Across the global financial press, the appointment of a new central banker garners celebrity-like media attention. A recent case in point was the appointment of Hyun Song Shin, who left the Bank for International Settlements to head the Bank of Korea. For the lay reader, this media frenzy around what are ostensibly mere technocrats and macroeconomic and monetary experts can be hard to comprehend.
The ongoing change of guard at the United States (US) Federal Reserve — the pre-eminent global central bank and the manager of the world’s key currency, the dollar — helps shed light on the stakes. As outgoing Fed Chair Jerome Powell makes way for his successor, Kevin Warsh, discussion in financial circles is as much about the Fed’s autonomy and credibility as it is about the incoming chair.
Referring to the White House investigation into alleged misuse of funds during a Fed renovation project, the outgoing Fed Chair said, “My concern is about legal attacks on the Fed, which threaten our ability to conduct monetary policy without regard to political factors.”
Following his last Federal Open Market Committee (FOMC) meeting — the body that sets US interest rates — as its Chair, Powell announced that he would break away from the norm and continue to serve as a Fed governor indefinitely. Referring to the White House investigation into alleged misuse of funds during a Fed renovation project, the outgoing Fed Chair said, “My concern is about legal attacks on the Fed, which threaten our ability to conduct monetary policy without regard to political factors.”
Powell would be the first Fed Chair since Marriner Eccles in 1948 to do so. Eccles continued to serve as a governor for three more years following his tenure as chair. Back then, both postwar US economic policy and the global Bretton Woods exchange rate system were still in infancy. Both the US and the global economy once again find themselves at a turning point.
While Warsh is a long-standing member of the global central banking community and was endorsed by a flurry of former and serving central bankers, the apprehensions about him are a feature, not a bug. Warsh’s appointment occurred in a highly politicised context and was effectively picked by US President Donald Trump, as he was the most likely candidate to cut interest rates. His recent US Senate approval highlights his contentious nature. It was the tightest vote for the Fed Chair in decades, with only one Democrat backing him.
The key concerns are his views on monetary policy, both as a former Fed governor and an investment banker, which have oscillated based on political convenience. For instance, Warsh advocated rate hikes in 2010, when the US was still reeling from the impact of the 2008 crisis. More broadly, he tended to support rate cuts when Republicans were in power, and vice versa.
Since his appointment by Trump, Warsh’s views have moderated significantly and seem closer to the median Fed opinion on monetary policy. In substance, he holds only one of the twelve votes at the FOMC.
Warsh’s appointment occurred in a highly politicised context and was effectively picked by US President Donald Trump, as he was the most likely candidate to cut interest rates.
As the Fed Chair, Warsh will have formidable agenda-setting powers; a clash with his other FOMC members remains a real possibility. On the day Warsh got Senate approval, the US reported its highest wholesale inflation since the 2022 Ukraine war energy shock. In this inflationary environment, much to Trump’s displeasure, Warsh will struggle to lower rates, increasing the likelihood of an early collision course with the Treasury and the White House.
Focusing only on the current moment misses the larger point about the more structural changes underway in the US and global economy. On that count, Powell’s decision to stay on tells a tale of two competing regime changes.
One is a regime change that Trump wanted to bring about at the Fed. The second is the end of the eras of Great Moderation and, arguably, Secular Stagnation, which resulted in a stable global macroeconomy from the late 1980s to 2007, followed by a global savings glut and an environment of low interest rates and low inflation. The post-COVID era has been gradually nudging towards a new global macro regime. In a nutshell, Powell has been trying to resist the first regime change to ensure the Fed is well-positioned to navigate the second regime change.
There are four elements of the new global macro regime:
First, at least in the developed world, the era of both easy money and low inflation seems to be over. How the Fed manages its economy affects the entire global economy, primarily through changes in demand, inflation, and capital and equity flows. For instance, both Fed policy and the state of the US labour market are key variables in how the Bank of England (BoE) sets its monetary policy, according to BoE’s external member, Megan Greene. Similarly, during the Fed’s taper tantrum in 2013, there were significant capital outflows across several emerging markets, including India.
Second, and relatedly, as Dario Perkins of TS Lombard points out, supply chain shocks will increasingly become the norm, keeping inflation from returning to pre-pandemic levels. Since the pandemic, there have been at least five major global supply shocks, including COVID-19, the Ukraine War, Houthi disruptions, Liberation Day tariffs, and the closure of the Strait of Hormuz. The recent rate hike by the Reserve Bank of Australia reflects how geopolitical shocks are now feeding directly into monetary policy decisions. As Greene argues, recurrent supply shocks force monetary policy into a constant catch-up role.
As Warsh takes office, he will be under immense pressure from financial markets, global central bankers, and his own Fed colleagues to prove his independence.
Third, as Aditi Sahasrabuddhe’s book, Bankers’ Trust, shows, close relations and seamless coordination among central bankers played a leading role in managing the fallout of the global financial crisis. With the global economy now significantly more prone to crisis, it is important for central bankers across the world to see their de facto leader, the Fed Chair, as an independent actor.
“Will other governments still take orders from Washington in a financial crisis, given the rise of geoeconomics and Trump’s capriciousness? It is dangerously unclear,” writes Gillian Tett in a recent column in the Financial Times.
Finally, the Fed has long used foreign exchange swaps with key global central banks during crises as a stabilising tool. Going forward, there is a rising risk that the US government could politicise them outright, tying these swaps to political concessions. How the Fed engages with the US Treasury will be critical for the state of the global financial system, especially when the next major crisis hits.
For these reasons, the independence and credibility of the Fed are central to the health of the global economy. As Warsh takes office, he will be under immense pressure from financial markets, global central bankers, and his own Fed colleagues to prove his independence. Unlike ordinary circumstances, his predecessor, Powell, will be watching him from inside the same room — like a savvy technocrat who has sharpened his political instincts.
Srijan Shukla is an Associate Fellow with the Centre for Economy and Growth Programme and the Forums team.
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Srijan Shukla is an Associate Fellow working with the geoeconomics and the forums team. His research focuses on domestic and international political economy. In the ...
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