The Case For A Smaller, Humbler Federal Reserve

For two decades, the Federal Reserve has behaved less like a central bank and more like the nation’s emergency room physician, trauma counselor and part-time life coach.

Markets sneeze, the Fed reaches for liquidity. Congress overspends, the Fed absorbs the debt. Asset bubbles inflate, then burst, and somehow the cure is always another round of intervention.

Enter Kevin Warsh, confirmed on May 13 as the 17th Chair of the Federal Reserve in a 54-45 Senate vote, one of the most contentious confirmations for a Fed chair. The margin reflects not the weakness of his qualifications, but the depth of resistance to what his appointment represents: a genuine rethinking of what the Fed is for, and what it should stop trying to do.

I first met Kevin in 2002, when we both worked in the White House. He was sharp, relentlessly prepared, and — this is the thing I remember most — genuinely skeptical about whether Washington’s instinct to intervene was always as helpful as it looked.

He later became, at 35, the youngest person ever to serve on the Federal Reserve’s Board of Governors, sitting alongside Ben Bernanke during the darkest moments of the 2007-08 financial crisis. Even then, what distinguished him was his willingness to question whether the Fed was doing too much, too often.

The case for reform rests on a straightforward proposition: the Federal Reserve has become too large, too discretionary and too confident it can manage outcomes it cannot predict. Since the financial crisis, it has evolved from lender of last resort into allocator of capital, guardian of asset prices and financier of chronic federal deficits. The Fed’s balance sheet expanded from roughly $900 billion before the crisis to nearly $9 trillion at its 2022 peak, and remains above $6.7 trillion today.

It’s a transformation we’re still reckoning with and is far from a policy adjustment.

Easy money inflated housing prices, fueled speculative excess, and gave Washington permission to believe deficits no longer carried consequences. They do.

Research from both the New York Fed and the Institute for New Economic Thinking suggests that quantitative easing (QE) inflated asset values in ways that disproportionately benefited wealthier households. Economists at the Bank for International Settlements and the National Bureau of Economic Research have documented how ultra-low rates distort markets and increase financial fragility.

Warsh has called publicly for “regime change” at the central bank: not dismantling it, but restoring limits on its responsibilities. That means a narrower mission: price stability and financial stability are hard enough without adding climate policy, inequality management or industrial strategy to the portfolio. It means treating QE as an emergency tool, not a permanent backstop. Investors should be expected to bear risk. Capitalism without the possibility of failure eventually becomes a subsidized speculation machine.

Reform means rules over improvisation. Milton Friedman warned for decades that discretionary monetary policy amplifies instability, that the long and variable lags between policy action and economic effect make fine-tuning not just difficult but actively destabilizing. The pandemic made this vivid.

The M2 money supply surged at a record pace during the pandemic, rising nearly 27% year-over-year by early 2021, the fastest increase since modern records began. You didn’t need an econometrics degree to see what was coming.

The Fed called the resulting inflation “transitory” throughout 2021, delaying tightening until March 2022 even as prices ran well above projections. Annual CPI hit 4.7% in 2021 and 8.0% in 2022 — the highest in four decades. The costs were borne not by economists in seminar rooms but by Americans paying more for groceries, rent, and gas.

Warsh was one of the earliest critics of the Fed’s complacency. He was right.

Monetary policy cannot substitute for growth policy. Low interest rates do not create productivity. Asset inflation is not prosperity.

For years, America tried to stimulate its way to abundance while underinvesting in its productive capacity. The Fed should stop trying to engineer expansion and let fiscal and regulatory policy do the heavy lifting.

Critics will warn that a less activist Fed means more volatility. But there is another kind of instability — the slow erosion that occurs when markets no longer believe prices or risk are real. Stable money is the precondition for reliable prices and sound economic calculation. When the unit of account shifts dramatically, the price system loses its ability to allocate resources efficiently. It doesn’t show up on a Bloomberg terminal, but it is far more dangerous.

At some point, emergency policy ceases to be exceptional, and it becomes the system itself.

Warsh arrives with firsthand experience of what went wrong, genuine conviction about how to fix it, and no illusions about the resistance ahead. The 45 senators who voted against him were not voting against his résumé. They were voting against the idea that the Fed’s era of boundless ambition should end.

That resistance is not an argument against reform. It is the case for it.

James Carter served as Associate Director of the National Economic Council under President George W. Bush, where he worked alongside Kevin Warsh. He is a Principal at Navigators Global and a former Deputy Assistant Secretary for Economic Policy at the U.S. Treasury.

The views and opinions expressed in this commentary are those of the author and do not reflect the official position of the Daily Caller News Foundation.