Warsh charts a forward-looking path for the Fed at Jackson Hole
This might be remembered as a moment when the central bank switched approach
Mohamed El-Erian
Kevin Warsh, chair of the US Federal Reserve, at the Kansas City Federal Reserve’s Jackson Hole Economic Policy Symposium on Friday © BloombergKevin Warsh delivered his first speech at the annual Jackson Hole central banking conference as the new chair of the Federal Reserve under the pressure of remarkably high and unusually varied expectations.
Yet in a powerful half-hour presentation, he went a long way towards assuaging doubts by deftly navigating both short- and long-term issues.
That’s the good news.
Less good is that the immediate media and market focus has been on the less consequential part of his speech.
We should not underestimate the tricky task Warsh faced in the run-up to his Friday speech: striking the right balance in responding to criticisms about the market’s lack of understanding of his so-called “reaction function” — how the Fed would respond to changes in the economy under his watch.
At the same time, he had to adhere to the symposium’s original objective (including this year’s focus on innovation) by addressing longer-term issues central to the economic outlook and Fed policy effectiveness.
Despite the considerable volume of Warsh’s writings and congressional testimony, some Wall Street commentators felt not enough was known about his reaction function.
They wanted not just details on this but also his current view of the economy and a bit of guidance on future policy.
It did not help that, in recent weeks, there has been more focus on inflation.
The criticisms of the reaction function and forward guidance, while misdirected, are understandable.
After all, for several years, the market has been conditioned by a Fed that relied on a mantra of “data dependency” for policy decisions, spoke often, and loved to issue forward guidance.
The result is something that Warsh and many others, including me, regret: to quote Warsh, “a market regime that looks to the Fed for its next trade” and, as such, plays the referee rather than the ball.
Warsh had other reasons to adhere to Jackson Hole’s original intentions.
We are living through a period of historic change driven by innovation-led transformation and the rise of geopolitical factors in economics.
Two other considerations have also fuelled the need for thinking about longer-term issues.
First, the approach taken by Warsh’s predecessor, Jay Powell, who tended to focus on shorter-term issues in his tenure.
Second was the importance of providing a “North Star” vision to help bring together, over time, a highly divided Federal Open Market Committee.
In response to these pressures, Warsh addressed the loud call for his views on the current state of the economy, the balance of risks to the Fed’s dual mandate on employment and price stability, and his commitment to using the Personal Consumption Expenditure index as the central bank’s preferred inflation target.
The resulting tone in this section, which has attracted the most media attention, was somewhat hawkish.
Warsh also restated his view that forward guidance has “outlived its role” and that it leads to the risk of the “hall of mirrors” phenomenon where the Fed and the market send back the same signals to each other.
He referred back to the Fed’s big 2021—22 policy mistake, in which prior incorrect forward guidance slowed the needed response, allowing consumer price inflation to surge to more than 9 per cent.
The result was a consequential hit to affordability and the compounded effects are still with us today.
Having said all this, the most important section of his speech pointed to the questions that the current phase of innovation poses for the economy and policy effectiveness, including the role of AI as a “new factor of production”.
While it has attracted less media attention, this is the most interesting and important part of his speech, as the issue has massive implications for economic functioning, the evolution of monetary policy and financial stability risks.
It is an area where a lot more work is urgently required.
Ultimately, Warsh delivered a masterclass in central bank communication at a pivotal juncture.
He addressed immediate market demands for details on his reaction function while, more importantly, putting the broader secular realities of productivity and AI front and centre.
If markets can look past the short-term headlines and spend more time on the ongoing strategic shifts, Jackson Hole 2026 may well be remembered as the moment the Federal Reserve began leading the forward-looking economic conversation once again, rather than merely reacting to the latest data.
The writer is the Rene M Kern professor of practice at Wharton School, chief economic adviser at Allianz and chair of Gramercy Funds Management
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