The Economic Headache That's Coming For Kevin Warsh

President Donald Trump’s pick to lead the Federal Reserve would inherit a healthy economy that most Americans believe is about to falter. If he’s confirmed by the Senate, Kevin Warsh may not have the right tools to restore their confidence.

The U.S. economy expanded at a torrid pace last year, and Wall Street analysts believe that will continue as businesses and consumers feel the effects of Trump’s new tax deductions and hefty refund checks. The Federal Reserve Bank of Atlanta estimates that gross domestic product is growing at a robust annual rate of more than 4 percent — double what economists projected for 2026— and businesses are squeezing much more output from their workers as adoption of artificial intelligence and other new technologies takes hold. The stock market has surged, generating trillions of dollars in new wealth for shareholders.

Still, most Americans have a grim view of what’s ahead: Hiring has slowed to a trickle, wage growth has decelerated, and consumer confidence has plunged beyond its pandemic-era depths.

Trump insists that the Fed’s next leader will pump up the economy by significantly reducing interest rates and recently joked about suing Warsh if he fails to follow through. But inflation remains elevated — which could make future cuts risky — and it’s far from clear that lowering short-term borrowing costs would immediately trigger a hiring boom that would boost the president’s approval rating. Warsh says he wants to cut rates, but that might not give Trump the economy he wants.

“The next Fed chair may face a dilemma in which strong growth and inflationary pressure is coming from the combination of tax cuts and the AI investment boom, but the labor market is barely treading water,” said Lael Brainard, a former Fed vice chair who later served as one of President Joe Biden’s top economic advisers.

That’s a complicated scenario for central bank policymakers in the best of circumstances. But the crosscurrents that Warsh and other Fed officials must navigate are going to be even more difficult “in a period where the economy is sending off mixed signals, and the White House is consistently pressuring the Fed to lower rates by a great deal to juice the economy in anticipation of the midterms,” Brainard added.

Outgoing Fed Chair Jerome Powell recently said the risks posed by inflation and unemployment have “diminished, but they still exist,” and sent a strong signal that central bank policymakers aren’t going to be in a rush to cut rates at their upcoming meetings. But Fed Gov. Christopher Waller — who was among the finalists to be Powell’s successor — argued for a cut, noting that upcoming revisions to the government’s labor market data are likely to show “that there was virtually no growth in payroll employment in 2025,” he wrote in a dissenting statement. “Zero. Zip. Nada.”

“This does not remotely look like a healthy labor market,” he said. “I have heard in multiple outreach meetings of planned layoffs in 2026. This indicates to me that there is considerable doubt about future employment growth and suggests that a substantial deterioration in the labor market is a significant risk.”

If that’s the case, Warsh and other Fed policymakers will have to consider whether those layoffs reflect fundamental changes to the labor market. Employers in certain sectors like housing and construction are especially sensitive to interest rates and would almost certainly expand head count if borrowing costs are brought down. But CEOs in financial services and technology have been limiting their workforce-expansion plans even as profits soared, a decision that some have attributed to the deployment of AI.

Warsh has written that AI is poised to spark a jump in productivity that will improve wages and lower inflation. But, as the economist Mohamed El-Erian noted in an interview with POLITICO, that outcome is contingent on companies adopting the technology in a way that doesn’t displace workers.

If the changes that are happening to the economy are structural, lower interest rates wouldn’t help, said Glenn Hubbard, who led the Council of Economic Advisers under President George W. Bush.

“Monetary policy is not the right tool to deal with that,” said Hubbard, a professor and former dean at Columbia University’s business school.

There was broad support among Fed policymakers to hold short-term borrowing costs steady at the most recent rate-setting meeting, Powell said last week. And while the labor market has softened in recent months, he said there are also signs of stabilization.

But the Labor Department’s monthly jobs report has also reflected a sharp decline in non-farm payrolls compared with their post-pandemic heights. Some of that is due to a decline in the supply of workers from the sharp drop-off in immigration, but some of it is also a result of weaker demand. Over time, that could create real tests for policymakers.

“That makes it a difficult time to read the labor market,” Powell said.

“Imagine they both came down a lot, to the point where there is no job growth. Is that full employment? In a sense, it is,” he added. “At the same time, do we really feel like that's a maximum employment economy? … It’s a very challenging and quite unusual situation.”

Patricia Zobel, a former monetary policy and markets official at the New York Fed who now leads macroeconomic research and market strategy at Guggenheim Partners Investment Management, said a stabilized labor market with low payroll growth could make it more difficult “to set monetary policy and assess whether or not the labor market is in balance.”

Regardless of whether the labor market is in balance, and unemployment remains near historical lows, a prolonged period of slow hiring isn’t going to reverse the dreary economic sentiment that has dragged down Trump’s approval numbers. Compared with a year ago, unemployed people are out of work for longer periods, and more workers are discouraged about their prospects for finding a new job.

In the meantime — as long as growth is humming and inflation is above the Fed’s stated target of 2 percent — Warsh will face pressure from other Fed policymakers to hold off on rate cuts that might result in higher prices.

As a Fed governor during the financial crisis, he was known for taking hawkish stances on central bank policies that could cause prices to spike. And as Powell can attest, Trump is unrelenting in his approach toward central bankers who stand in the way of easing financial conditions.

If circumstances call for higher interest rates, “how the chairman navigates the politics of that — and manages pressure from the White House — is going to be a really important test of that person's time in office,” said Michael Strain, the director of economic policy studies at the right-leaning American Enterprise Institute.