Acting Federal Reserve Chairman Kevin Warsh made a bold statement during yesterday's Congressional hearings. He acknowledged that the inflation strategy adopted by the Fed in 2020 was a mistake and promised to radically overhaul the regulator's approach to price stability. This statement came ahead of his second day of testimony before the Senate.
Warsh made it clear: the Fed will no longer tolerate prolonged price increases. He vowed to prioritize strict control over inflation, a focus the regulator had effectively abandoned in favor of temporary support for the labor market. In essence, the new central bank chief announced a complete policy reversal.
What was the fatal error of the 2020 strategy?
Recall that in 2020, under the leadership of Jerome Powell, the Fed adopted the concept of "flexible average inflation targeting." Instead of a strict 2% limit, the regulator allowed inflation to temporarily exceed this mark, assuming that price growth rates would balance out on their own in the long term. Moreover, the Fed leadership deliberately allowed a temporary overheating of the economy to stimulate job creation, paying particular attention to vulnerable segments of the population.
It is this shift in focus that Warsh considers the key problem. In his view, attempts to manage employment through inflationary policy go beyond the Fed's mandate. "This central bank was not the first to try to raise inflation a little and end up with much more. It was a mistake," he stated from the podium.
Why does Warsh call it a mistake and what happens next?
Since 2021, inflation has exceeded the 2% target every year. According to Warsh, the new policy only allowed price growth to persist longer than necessary. He noted that this strategy was abandoned even before he assumed the role of Fed Chairman two months ago. Now, his task is to complete the work already begun on regaining control over inflation, rather than starting from scratch.
Although a detailed reform plan is not yet available, the new leader has already formed five special working groups. Experts will focus on reshaping key areas of monetary policy. Warsh himself described the process as a five-pronged reform. More specifics will emerge once the working groups finish preparing their proposals.
He made it clear to Congress: the Fed's task is to return inflation to 2% without any reservations or compromises, not to try to navigate between different goals. This approach correlates with his recent forecast on interest rates. As of today, June inflation data came in below expectations, giving the Fed room to maintain rates, especially amid reduced recession risks. On July 15, Warsh will again testify on Capitol Hill, where he is likely expected to provide concrete explanations of how the working groups' initiatives will translate into actual Fed policy.
Expert opinion: Warsh's admission is not just a shift in rhetoric, but a tectonic shift in the Fed's approach. For the crypto market, which is sensitive to liquidity, a return to strict inflation targeting without regard for the labor market signals a potentially longer period of high interest rates. This could dampen risk appetite in the short term, but in the long term, it creates a more predictable macroeconomic environment, which is a positive factor for institutional adoption of digital assets.