A CHANGE IN LEADERSHIP. The Fed is the central bank of the United States. It is responsible for keeping the financial system running smoothly. In 2026, the Fed will see its leadership change. The current chair will retire, and former Fed Governor Kevin Warsh has been nominated to replace him. A new approach to monetary policy Mr. Warsh is a vocal critic of certain Fed policies. He has argued that quantitative easing (QE), which is the Fed’s practice of purchasing U.S. government bonds to stabilize the financial system, encouraged Congress to spend more than it otherwise might have. In an April 2025 lecture, Warsh explained: “In the 2008 crisis, we cut interest rates to near zero and sought new ways to make monetary policy looser and bring liquidity to illiquid markets. I strongly supported this crisis-time innovation, then and now. But when the crisis ended, the Fed never retraced its steps…QE – with some fits and starts in the 2010s – has become a near permanent feature of central bank power and policy. Fiscal policymakers – that is, elected members of Congress – found it considerably easier appropriating money knowing that the government’s financing costs would be subsidized by the central bank.” Retracing the Fed’s steps One of Warsh’s priorities as Fed Chair may be reducing the central bank’s balance sheet, and there has considerable speculation about how this might be accomplished. Alex Harris of Bloomberg reported on several possibilities. These included: - Reducing Treasury purchases. The Fed ended its latest round of quantitative tightening (QT) in December because bank reserves (the cash banks are required to keep on hand to ensure the stability of the system) were falling too low, creating stress in the system. The stress became significant enough that the Fed resumed bond purchases.
“While restarting QT is unlikely, the Fed could gradually reduce the pace of T-bill purchases from $40 billion a month currently, or stop them altogether,” according to analysts cited by Harris. - Changing regulations. If bank reserve requirements were modified, the effect of QT on bank reserves could be reduced. “Regulators could relax the liquidity coverage ratio or internal liquidity stress test requirements, so lenders need to hold less cash,” suggested bank strategists cited by Harris.
- Exchanging assets. Another option is for the Fed to sell longer-term Treasuries and buy shorter-term Treasury bills, which mature in 12 months or less. “But without close coordination with Treasury, long-dated debt issuance needs and costs would rise significantly as the Fed retreats,” wrote Harris. One estimate suggested the change could push “borrowing costs up by 40 to 50 basis points.”
Warsh has expressed support for a more coordinated approach between the Fed and the U.S. Treasury Department, which could help mitigate the effects of Fed balance sheet reduction efforts, according to Ye Xie, Michael MacKenzie, and Maria Eloisa Capurro of Bloomberg. However, greater coordination could also raise questions about whether the Fed is acting independently. The Fed will face another significant challenge during Warsh’s tenure: managing monetary policy in an economy being transformed by AI. We’ll explore that next week. WEEKLY FOCUS – THINK ABOUT IT “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.” – Winston Churchill, Former British Prime Minister
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