America’s next Fed chair is caught in a vice

RUNNING THE Federal Reserve is generally considered one of the world’s great jobs. Running America’s central bank with Donald Trump in the White House is a rather thornier proposition. Jerome Powell, the current chair, is the subject of regular presidential tirades. “Where is the Federal Reserve chairman, Jerome ‘Too Late’ Powell, today?” asked Mr Trump on Truth Social, his social network, as his war in Iran sent markets lurching lower last month. Mr Powell is also the subject of a spurious investigation by the Department of Justice (DoJ) into the bill for renovating the Fed’s headquarters.

Kevin Warsh may have hoped for an easier run of things. In January, when Mr Trump nominated the former Fed governor to succeed Mr Powell, consensus in markets was of at least one or two cuts in interest rates, and probably more, before the end of 2026. That would not have got today’s 3.5-3.75% down to the 1% or so that the president occasionally demands. But it might at least have kept Mr Warsh out of the crosshairs.

Since then the case for those rate cuts has evaporated (see chart 1). Few now expect any this year. Most obviously, war in Iran has sent the price of oil soaring, pushing headline inflation to an annual rate of 3.3% in March, up from 2.4% the month before, according to official figures released on April 10th. The next month’s data will probably also be painful for similar reasons. Despite a (tentative) ceasefire in the Gulf, oil prices are still hovering around $95 a barrel, a third higher than before America and Israel attacked the Islamic Republic in late February.

Oil shocks tend to percolate, in time, to other prices around the economy: energy is, after all, an input in nearly everything. America went through a similar experience in 2022, after Russia invaded Ukraine. Reducing interest rates to stimulate the economy while prices are marching up is, for the most part, a central-banking no-no.

Complicating life for Mr Warsh, American price stability was already deteriorating before the war. Mr Trump’s tariff shock may have been a one-off, raising the level of goods prices as importers gradually passed the cost on to customers, but not the rate of inflation. Services inflation, though, which tends to be less jumpy and better reflects how hot the economy is, has stopped falling.

Exclude housing (which tends to lag behind other prices because rents are typically reset only once a year) and prices of services—anything from haircuts and car rentals to mobile-phone plans—are rising about half a percentage point faster than their average in the 2010s, when inflation consistently hit the Fed’s target of 2% (see chart 2). That is not a huge gap. But it suggests that inflationary pressure has not been fully squeezed out of the American economy, making additional monetary stimulus hard to justify.

This is an empirical blow to Mr Warsh’s rate-cutting project. Another challenge is theoretical—but no less potent for it. An erstwhile inflation hawk, he got into Mr Trump’s good graces by arguing that productivity growth brought about by artificial intelligence justified sharp reductions in interest rates.

This argument was always shaky. If AI really were to make American workers vastly more productive, and soon, the correct monetary response might well be to raise interest rates. That is because the “neutral rate”—which neither stimulates nor stifles output—tends to rise and fall with the economy’s underlying growth potential. Moreover, so far the most obvious economic impact of the AI boom has been a huge wave of investment in data centres. By ploughing billions into the economy, this splurge pushes against the notion of lowering rates.

In the past few months, some senior Fed officials have laid out their disagreements with Mr Warsh’s AI optimism (without being so impolitic as to name him specifically). Philip Jefferson, vice-chair at the Fed, said in a speech in February that AI may well raise inflation in the short term and pull up the neutral rate in the long term. Later that month Michael Barr, another Fed governor, gave remarks making similar points. Even Mr Powell has weighed in. During the most recent Fed press conference he told The Economist that with AI, “you’re not looking at something that would immediately call for lower rates or that would be lowering inflation.”

And Mr Powell may be around for a while. He has said that, unlike his recent predecessors, he does not plan to step down from the Fed’s board of governors when his term as chair expires in May, at least until the DoJ probe ends. (His term as a governor runs until 2028.) If some recalcitrant Republican senators stick to their pledge not to confirm any new Fed appointees, including Mr Warsh, until the probe wraps up, he could even stay as chair pro tempore beyond May. On April 15th Mr Trump vowed to sack Mr Powell if he does not depart—although it is not clear he has the legal authority to do so. He also said that the investigation would continue.

Mr Warsh’s metamorphosis into an inflation dove has allowed him to sweet-talk the president into offering him the Fed job. Now that Mr Trump’s Iran mess has made interest-rate cuts trickier, explaining to the president that he cannot have the reductions he wants will require something even more saccharine. ■