Kevin Warsh has yet to assume office, but he is already embroiled in an intense debate over AI, inflation, and monetary policy—caught between political pressure from Trump and professional skepticism from economists.
According to a real-time economist survey by the Financial Times, top academics have refuted Kevin Warsh’s claim that an AI-driven productivity boom will create room for rate cuts, highlighting the challenges faced by Trump’s pick for Federal Reserve Chair.
Trump nominated Warsh to succeed Powell at the end of January. Warsh argued that AI would trigger "the strongest wave of productivity increases we have seen in the past, present, and future." He stated this would boost output and pave the way for the Fed to lower US borrowing costs from their current level of 3.5%-3.75% without triggering price hikes.
The Clark Center for Global Markets at the University of Chicago surveyed 45 economists this week, and nearly 60% said the technology’s impact on prices and borrowing costs over the next two years would be minimal, with PCE inflation and the neutral interest rate expected to fall by less than 0.2 percentage points over that period.
"I don’t view the AI boom as a disinflationary shock," said Jonathan Wright, an economist at Johns Hopkins University and former Fed official. "But I also don’t think it will cause significant inflation in the short term."
About one-third of respondents said the AI boom might even force the Fed to slightly raise the so-called 'neutral interest rate,' the level at which borrowing costs neither stimulate nor restrain demand.
Warsh must secure Senate confirmation to take over from Powell in mid-May, and he has been focusing on AI's impact on productivity.
However, other economists, including some within the Fed, argue that for now, the impact of this technology could increase demand and price pressures.
"Even if AI ultimately succeeds in significantly boosting the economy’s productive capacity, the more immediate rise in demand associated with AI-related activities could temporarily push up inflation unless offset by appropriate monetary policy actions," said Philip Jefferson, the Fed’s Vice Chair for Monetary Policy, at an event hosted by the Brookings Institution last Friday, citing the impact of the data center construction boom.
Gaining support from other members of the Federal Open Market Committee (FOMC) for the prospect of a rapid AI-driven productivity boom could prove tricky, making it difficult for Warsh to implement the scale of rate cuts Trump desires ahead of the November midterm elections.
The FOMC's forecast indicates that there will only be one interest rate cut this year, by 25 basis points, keeping the benchmark rate above 3.25%, which is significantly higher than the 1% rate that Trump claims the U.S. economy needs.
Warsh believes that the Federal Reserve should reduce what he calls its 'bloated' balance sheet, a view that could also provoke dissatisfaction among other U.S. interest rate setters.
The FOMC recently supported a decision to end a three-year policy of 'quantitative tightening,' which reduced the central bank's asset size from just under $9 trillion to $6.6 trillion amid tensions in the money markets.
Investors believe that aggressively reducing the balance sheet would increase long-term borrowing costs, potentially pushing up mortgage rates and angering the White House, which is concerned that housing affordability could affect their votes.
However, more than three-quarters of poll respondents believe that the Fed's balance sheet should fall below $6 trillion two years from now.
"Further moderate reductions in the balance sheet may not be unreasonable if based on conditional grounds, provided there is sustained evidence that liquidity remains ample and short-term funding markets remain stable," said Harvard University professor Karen Dynan.
An equivalent proportion expects Warsh to successfully achieve his goal, bringing the balance sheet closer to its pre-2008 scale of less than $1 trillion.
The apparent contradiction between Warsh's dovish stance on cutting short-term rates and his hawkish position on the balance sheet raises questions about how someone who has spent much time criticizing the Federal Reserve but less time proposing solutions would manage the U.S. central bank.
"This is fraught with uncertainty," said Jane Ryngaert of Notre Dame University. "It's hard to draw conclusions about anything."
Others emphasized the extent to which developments could either align with or contradict the worldview of the former Fed governor.
"The AI boom could bring economic prosperity, shrinking budget deficits, higher neutral interest rates, and a comfortable contraction of the Federal Reserve's balance sheet," said Robert Barbera, an economist at Johns Hopkins University. "Or we might experience a financial market crash, a deep recession, a sharp rise in deficits, forcing short-term interest rates back to zero, a plunge in the dollar, and a demand for another massive dose of balance sheet expansion."
Most respondents do not support the Trump administration’s goal of loosening regulations on the banking system—a position advocated by Warsh—with over 60% indicating that it would have little impact on growth in the short term but would substantially increase the risk of a financial crisis.
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