The Imperatives of a Warsh Fed

The debate around Kevin Warsh’s likely elevation to the chair of the Federal Reserve has been framed as a question of ideology, hawk versus dove, rules versus discretion. That framing misses the more important point. A Warsh chairmanship would be shaped less by doctrine than by a set of imperatives imposed by the Federal Reserve’s own post-crisis architecture and the limits of balance-sheet-driven policy.

Over the past two decades, the Fed’s toolkit has expanded well beyond its pre-2008 contours. Before the global financial crisis, the Fed’s balance sheet hovered around $800 billion, roughly 6% of nominal GDP, and consisted largely of Treasury securities funded by currency in circulation. Today, even after substantial runoff, the balance sheet stands near $6.6 trillion, about 22% of GDP. At its peak in early 2022, it approached $9 trillion. Had it merely grown in line with nominal output, it would be closer to $1.7 trillion today.

What began as an emergency response became embedded as an operating practice.

Large-scale asset purchases, forward guidance and an ample-reserves regime evolved from crisis tools explainable by necessity into permanent features of monetary policy. That evolution delivered stability during moments of stress. It also created new constraints. A Warsh Fed would be forced to confront those constraints directly.

Restoring the primacy of interest rates
The first imperative is to re-establish interest rates as the Fed’s primary policy signal. As quantitative easing became persistent rather than episodic, the informational role of the policy rate diminished. Financial conditions increasingly reflected balance-sheet expectations rather than the stance embedded in the federal funds rate itself.

This matters for the Fed’s mandate.

Inflation expectations and employment outcomes depend not only on the level of rates but on their signalling power. A regime in which the balance sheet does most of the work leaves rates informationally impoverished, blurring the transmission mechanism and complicating communication. The result is a policy stance that is powerful but opaque.

Warsh has long argued that monetary policy exceeded its comparative advantage by attempting to fine-tune long-term financial conditions through asset holdings rather than using the short-term rate as the central stabilisation instrument. The implication is not that balance-sheet tools should never be used, but that they should not substitute for rate policy once crisis conditions pass.

Defining a neutral balance sheet
The second imperative is conceptual but unavoidable: defining an operationally neutral balance sheet. Central banks debate the neutral rate endlessly, even though it is unobservable. By contrast, they have largely avoided defining what constitutes an appropriate steady-state balance-sheet size, despite the fiscal, market and political consequences of persistent excess reserves.

Since 2008, the Fed has moved from a scarce-reserves system to an ample-reserves regime, explicitly committing in 2019 to operating with reserves abundant enough to ensure control over short-term rates without daily market intervention. That framework proved invaluable during the pandemic, when rates returned to the zero lower bound, and liquidity ensured survival.

Yet ample reserves are not costless. Paying interest on reserves turns balance-sheet size into a quasi-fiscal variable. Excess liquidity also reshapes market behaviour, compressing term premia and muting price discovery. Warsh’s criticism has been less about QE’s crisis role and more about the absence of an end-state. Without a defined destination, balance-sheet policy drifted.

A Warsh Fed would likely press for serious analytical work on what constitutes a balance sheet that is “ample but not abundant”, sufficient to ensure operational control without becoming the dominant allocator of duration risk. That is an institutional question that squarely relates to the Fed’s mandate.

Decoupling easing from asset purchases
The third imperative follows logically: decoupling monetary easing from asset purchases. Since 2008, rate cuts and balance-sheet expansion have been tightly linked in market expectations. Easing came to mean not just lower short-term rates, but renewed QE.

Warsh has challenged that linkage. His argument, controversial but coherent, is that a smaller balance sheet can reopen space for conventional rate cuts without undermining financial stability. In this framing, balance-sheet shrinkage is not tightening by stealth, but a prerequisite for restoring the effectiveness of rates as a policy tool.

This is not without risk. The Fed’s experience between 2022 and 2025, when balance-sheet runoff coincided with emerging money-market strains as reserves fell, underscored the difficulty of calibrating reserve scarcity. An economy growing in nominal terms requires a growing stock of reserves. Misjudging that threshold could destabilise funding markets.

Even so, the direction of travel is clear. A regime of rate cuts without renewed QE would represent the first sustained attempt since the global financial crisis to separate signalling from balance-sheet footprint. It would also force markets to price long-term risk without assuming a permanent central-bank backstop.

Accepting volatility as a by-product of credibility
The fourth imperative is perhaps the most uncomfortable: accepting higher volatility as the price of credibility. Financial stability has increasingly been conflated with asset-price stability. A Warsh Fed would likely reject that equivalence.

If the Fed withdraws from systematic suppression of term premia, long-term yields would drift higher, not necessarily because growth or inflation prospects worsen, but because investors demand compensation for duration and uncertainty. Multiples would no longer expand automatically. Corporate earnings, rather than liquidity abundance, would do more of the work in valuation.

This shift would not be a policy objective. It would be a consequence of removing implicit guarantees. Over time, however, genuine price discovery improves allocative efficiency, which ultimately supports sustainable employment and price stability. Volatility, in this sense, is not a failure of policy but evidence that markets are once again bearing risk.

Global spillovers, not global targets
For emerging markets, the implications would be structural rather than cyclical. Over the past fifteen years, abundant global liquidity mattered more than the cost of liquidity. Capital flows, reserve accumulation and asset prices in emerging economies were shaped by the availability of excess dollars created by the Fed’s balance-sheet expansion.

A smaller, more disciplined Fed balance sheet would alter that environment. Even if US policy rates were cut, the absence of renewed QE would limit global liquidity spillovers. Reserve accumulation by emerging-market central banks would likely slow. Monetary policy divergence would persist, as domestic conditions rather than the Fed’s cycle dominate decision-making.

These outcomes are not objectives of a Warsh Fed. They are consequences of a monetary regime more tightly aligned with domestic mandate execution.

Formalising an adjustment already underway
Much of this adjustment is already visible. Markets have begun to price a world in which liquidity is scarcer, term premia are positive, and policy explains that stability does not mean perpetual accommodation. In that sense, a Warsh chairmanship would not inaugurate a radical new regime.

It would formalise the end of one whose limits have become increasingly apparent.

The imperatives facing the next Fed chair are not ideological choices. They are institutional necessities shaped by the legacy of extraordinary policy. A Warsh Fed would be defined less by what it believes than by what the framework now requires.

BasisPoint Briefing — Explainers from seasoned practitioners for readers who want more than the basics.