Kevin Warsh could become the next Paul Volcker

February 10, 2011

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Kevin Warsh’s resignation as a governor of the Federal Reserve removes one of Chairman Ben Bernanke’s closest advisors — and almost certainly the most hawkish of his inner circle. If current policies produce 1970s-style inflation, as many of Bernanke’s critics predict, Warsh could be well placed to take over as Paul Volcker did in 1979.

While Warsh voted with his bearded boss on monetary policy matters, as is Fed tradition, the youthful former investment banker has made publicly clear his concerns over recent financial policy, writing in November that “chronic short-termism in the conduct of economic policy has done much to bring us to this parlous point.”

The Republican Warsh, who is both a fiscal hawk and a proponent of higher savings rates, has said that he believes “sound fiscal policy must do more than reacquaint consumers with old bad habits.” He has also said that “responsible monetary policy in the current environment requires attention not only to near-term macroeconomic conditions, but also to corollary risks with long-term effects.”

So Warsh’s imminent departure would appear to deprive Bernanke of an intellectual sparring partner, strengthening the hand of the doves on the Fed board. However, assuming he does not depart the monetary policy arena to run for political office or return to Wall Street, he represents a kind of secret weapon for monetary hawks, should current policies produce resurgent inflation and its attendant woes.

Outside the Fed he will be better placed to make the case for monetary stringency than while belonging to the collegial Board of Governors. In extremis, should a spike in inflation or a financial market crash remove the credibility of current Fed policies, Warsh would be available as a replacement, either when Bernanke’s current term ends in January 2014 or earlier, in a crisis.

That’s sort of what happened when Paul Volcker was appointed Fed chairman to replace G. William Miller, who had lost the faith of bond markets. As a known Republican, Warsh would presumably be passed over by President Obama. But at 40 he is a relative spring chicken. Harder money advocates who felt they lacked a potential replacement for Bernanke (Volcker was born in 1927) may find succor in Warsh’s decision.

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