Kevin Warsh Calls Fed’s Flexible Inflation Framework a Mistake: What Happens Next?

Federal Reserve Chair Kevin Warsh told Congress yesterday, July 14, that the central bank’s 2020 approach to managing inflation was a mistake, pledging a policy “regime change” as he prepares for a second day of testimony before the Senate.

Warsh added the Fed has no tolerance for persistently elevated inflation and vowed to restore the price stability mandate that the 2020 policy set aside.

What the 2020 Framework Actually Did

In 2020, under then-Chair Jerome Powell, the Fed adopted a policy called flexible average inflation targeting. Instead of treating 2% as a hard ceiling, the framework let inflation run moderately above that target for a stretch, as long as it had spent time running below target beforehand. The idea was to average price growth out over time rather than react to every short-term swing.

Inflation has come down from its 2022 highs, but has not settled below 2% in the last 5 years. Image Source: Trading Economics.

The framework had a second, less publicized goal. It also let the Fed tolerate a period of above-target inflation if doing so helped support employment, particularly for workers left behind in earlier recoveries. That employment-focused tradeoff is the piece of the policy Warsh singled out.

Why Warsh Calls It a Mistake

Warsh testified before the House Financial Services Committee that using inflation policy to manage employment outcomes falls outside what the Fed should be doing.

“That central bank wasn’t the first central bank to ask for a little more inflation and end up with a lot more. It was a mistake.”

Inflation has run above the Fed’s 2% mandate every year since 2021, and Warsh argues the 2020 framework gave the Fed cover to let it run hotter for longer than it should have. He noted the policy was already abandoned before he took over as chair two months ago, framing his job now as finishing the cleanup rather than starting it.

“The framework did not succeed in its objectives, and I am pleased that before my arrival, my predecessors took that and cast it aside.”

What Warsh Wants Instead

Warsh has not proposed a replacement framework in detail, but he has set up five internal task forces to rebuild how the Fed operates: its public communications, its technology, its balance sheet, the economic data it relies on, and the methodology it uses to measure inflation itself.

He described the effort as reform across five dimensions of monetary policy, with more detail expected as the task forces report back.

The message to Congress was that the Fed’s job is to bring inflation back to 2% without ambiguity or tradeoffs, not to manage it flexibly around other goals.

That stance follows his rate hike outlook preview published ahead of the hearing, and lands just as June inflation data came in cooler than expected, even as economists flagged AI-driven inflation risk tied to data center spending. That optimism comes alongside lower recession risk estimates that give the Fed more room to hold rates steady.

Warsh returns to Capitol Hill tomorrow, July 15, for bank earnings week testimony before the Senate Banking Committee, where lawmakers are likely to press him on how the task forces’ work will translate into an actual policy framework.

Read the article at BeInCrypto