The Federal Reserve got a new leader last Friday, but his power may not be as vast as it might seem. The Senate confirmed Kevin Warsh, President Trump's pick for Fed chair, in a 54-45 vote on Wednesday. Mr. Trump's goals for the monetary policy job are not difficult to discern: he has openly pressed the Fed to slash interest rates for months, and has repeatedly lashed out at outgoing Chair Jerome Powell for not rapidly cutting rates. Warsh, who has vowed to be an independent actor and said he will not set policy based on the President's views, will get a chance to weigh in next month, when the Fed's interest rate-setting committee is scheduled to have its next meeting. His plans are not clear. He suggested some openness to rate cuts last year, but in a prior stint as a member of the Fed's Board of Governors, he was known for favouring tighter monetary policy.
The thing is, he won't be able to decide on rates all on his own. Fed chairs usually have a great deal of influence over the rate-setting committee, but their power is not absolute. So, it is expected that Warsh will need to work to form a consensus on the right path forward. A tricky task by any stretch of the imagination in an economic landscape marked by uncertainty, fears about the Iran war and a stubborn inflation problem. Most Wall Street financial analysts expect interest rates to remain steady for the next few months. Plus, at least for now, Jerome Powell, the President's nemesis, is planning to remain on the Fed Board, after a controversial criminal probe by the Justice Department led him to stick around.
The Power of Speech
While the chair has the power to persuade and is in a very strong position to be able to persuade, the reality is that he or she still needs to persuade. Interest rate targets are set not by the Fed chair, but by the Federal Open Market Committee, which meets eight times a year. Technically, the chair has just one vote out of the committee's 12 members. Seven of the committee's voting members, the Fed governors, are directly nominated by the president, and they serve 14-year terms, giving a single administration limited power over the Fed's makeup. Currently, three Fed governors are Trump appointees, including Warsh. Three others are Biden appointees, and the seventh is Powell, who was first named to the Fed board during the Obama administration and made chair during the first Trump administration.
The FOMC's other five seats belong to the president of the New York Federal Reserve and a rotating cast of four of the 11 other regional Fed bank chiefs. The White House has very little control over the regional Fed presidents, who are hired for five-year terms by the board of each regional bank and then approved by the Fed's Board of Governors. In other words, at least for the time being, just a quarter of the interest rate-setting committee's members are directly President Trump's appointees. There is also no guarantee that Trump's appointees will side with the president. After all, Powell was also appointed chair originally by Mr. Trump himself. Still, former Fed officials say the chair's influence over the FOMC extends well beyond their single vote.
Past in Perspective
However, in some cases, Fed chairs have built up "soft power", provided a chair has a track record of making good decisions. If so, the co-members may be willing to cut the chair some slack. Also, invariably, both the chair and the rank-and-file committee members usually want to emerge from meetings with a consensus, and this helps, as it conveys more force to the marketplace. Markets will pick up on a consensus vote, and might react differently than they would if it were a more fragmented-looking vote. So, naturally, the chair has a great incentive to get the consensus of all the voting members.
Rethinking Governance
The process of forming a consensus starts a few days before the panel meets, with the chair calling up or sitting down with regional Fed presidents and board members. More often than not, one gets a pretty good idea of where people are typically going to stand before the meeting begins. Importantly, in practice, the economists and other staff who work for the Fed's Board of Governors also report to the chair, so economic forecasts and other information often go to the chair before anybody else. With this heads-up, the chair has a lot of ability to direct the staff to focus on particular issues. Then, when the meeting rolls around, the chair and other members spend two days sharing their views about the state of the economy and discussing the correct path forward, including whether to make changes to their target interest rate, known as the federal funds rate. The chair usually serves as "the focal point for the discussions" and helps prepare the policy options that they weigh. The chair's job is to talk to everybody and try to convince them that the chair is right. In the end, the chair may not get the outcome that they want, but it gets the committee to move as far as it can.
Building a Shared Future
The final product is a short statement that lays out what actions the committee chose to take and describes, sometimes vaguely, how it views the future. Investors meticulously scrutinise the statement, looking for tiny wording changes that could signal what the committee is planning to do next. For that reason, members discuss the statement in extreme detail, just like before releasing the directors' report to the stock exchange at the time of results announcements. It is common knowledge now that this statement gets argued over quite extensively, including commas, quotation marks and new words — the smallest little bits are the subject of great debate. In the end, these things are often close calls, and it is not uncommon that, in some cases, members may defer to the chair for a decision, but at the same time put down markers on their concerns about the direction of the economy; something that restricts the room for manoeuvre for the chair. Only time will tell how Warsh's equation with President Trump will take shape, or whether it will just lead to another Jerome Powell moment.
