Former US Federal Reserve Board member Kevin Warsh spoke with CNBC on July 17, 2025.
CNBC
When Kevin Warsh becomes Federal Reserve chairman, he could face a buzzsaw: Hobson’s choice between fighting inflation and protecting the labor market.
The Fed has a duty to support the sometimes contradictory dual mandate of price stability and full employment.
There are basically three ways to do this. They can either raise interest rates to suppress demand and fight inflation, lower them to support economic growth and employment, or, best of all, keep interest rates where they are to maintain a balance between the two.
But the deteriorating economic situation suggests that when Mr. Warsh takes office, perhaps in May, central bank policymakers could face both a precarious employment situation and persistent inflation, exacerbated by soaring energy prices.
“He’s got a perfect storm here,” said Troy Rutka, senior U.S. economist at SMBC Nikko Securities. “We’re seeing some significant stagflation pressures, particularly from the manufacturing and goods sectors of the economy. This is coming at a time when it looks like consumers are really starting to see – I don’t want to say collapse, but maybe starting to collapse.”
Stagflation, or high inflation and low growth, is Fed officials’ worst nightmare. That means having to prioritize one side of the mission over the other, and potentially risking losing both.
In the current environment, the Iran war has caused energy prices to rise sharply, with U.S. crude oil at one point soaring more than $100 a barrel on Monday, before falling after President Donald Trump gave assurances that the conflict would soon end.
But for Warsh, the stakes are especially high.
difficult choice
President Trump has made no secret that he expects Warsh to push for significant interest rate cuts. The president and other administration officials have argued, at least since before the war began, that inflation is no longer a significant threat to the economy and that the Fed should continue the interest rate cuts it began last September.
It may not be so easy to please the president.
Even before the energy surge, manufacturing costs were rising. The Institute for Supply Management’s price index hit a nearly four-year high in February, and purchasing managers at U.S. factories reported continued rises in costs, partly due to President Trump’s tariffs.
Lutka warned that headline inflation could exceed 3% if energy prices remain high, even as consumer credit is under pressure and the labor market appears to be softening.
Economists generally believe that the ripple effects on the economy as a whole from rising energy prices are low. However, since the fighting began, the price of urea fertilizer has increased by 15%. Rising fertilizer costs often lead to higher food prices, increasing the likelihood of new inflationary pressures in the future.
For his part, Warsh faces a Federal Open Market Committee that is already divided over the future direction of policy. Central bankers typically view oil shocks as drivers of long-term economic trends, but they may have little choice but to deal with long-term disruptions.
There is still a chance of a rate cut
“He faces an environment where the committee is extremely divided, and that division will only get deeper from here,” Lutka said. “If oil prices remain high and inflation is likely to remain well-supported despite the weak labor market, we will be forced to move in either direction.”
Lutka added that despite the threat of higher inflation, he believes “the path of least resistance for policymakers is to lower interest rates.”
One advantage the Fed, and incoming Chairman George Warsh, has is consumers who continue to spend, but that power is concentrated in high-income households.
Personal spending rose 3.2% in February compared to the same month last year, the largest increase in three years, according to Bank of America data. However, the company noted that after-tax wage growth for high-income earners increased by 4.2% annually, compared to just 0.6% for lower-income earners, the largest difference in a series of data since 2015.
Monetary policy has proven to be an ineffective weapon against inequality.
Still, further signs that consumers, especially low-income consumers, are suffering from both high prices and a weak labor market could prompt Fed officials to look for a temporary spike in oil prices.
Economists at Bank of America also think the market may be misreading the current situation by expecting the Fed to automatically prioritize inflation. Traders in recent days have withdrawn hopes for rate cuts, predicting the first round of measures won’t take effect until September and the second until 2027.
“The market’s reaction to the rise in oil prices has been largely hawkish,” BofA economist Aditya Bhave said in a note. The hawkish Federal Reserve focuses on inflation and tends to keep interest rates high. “This may be a mistake.”
Correction: In the current environment, the Iran war has caused energy prices to rise sharply, with U.S. crude oil at one point soaring above $100 per barrel on Monday. In previous versions, conflicts were named incorrectly.
