(Yicai) May 13 -- Kevin Warsh is likely to take over as chairman of the Federal Reserve before May 15, leading the world’s most influential central bank. His core view is that the US should enhance its own productivity and reinforce the dominance of the US dollar to counter the challenges posed by China’s rise in global competition.

Warsh has long criticized the Federal Reserve’s overreliance on the core personal consumption expenditure (PCE) price index, which excludes food and energy prices, as an inflation anchor. He argues that core PCE is easily distorted by one-off external shocks, such as tariff adjustments and energy crises triggered by geopolitical tensions, making it an unreliable reflection of underlying inflation trends and potentially leading to policy misjudgments. From a policy perspective, Warsh plans to shift the Federal Reserve’s inflation monitoring focus toward the trimmed mean PCE.

This indicator effectively filters out short-term disturbances by excluding the highest and lowest extremes in price fluctuations. Currently, it shows that the US inflation rate stands at 2.4 percent, significantly lower than the overall inflation rate of 3.5 percent and the core inflation rate of 3.2 percent, bringing it closer to the Federal Reserve’s 2 percent inflation target. It is important to clarify that this shift in indicators is not merely a technical adjustment; its core policy implication is to provide theoretical support for interest rate cuts.

In other words, even if consumer prices remain elevated, the Federal Reserve could still proceed with interest rate cuts based on the judgment that “core inflation trends have stabilized.” This approach contrasts sharply with the cautious stance during Jerome Powell’s tenure, which focused on headline and core inflation as key anchors. Furthermore, this strategy carries important implications in the context of trade tensions with China, as it may become a crucial tool for Warsh to address tariff impacts and support competition with China.

Reconstructing the Linkage Between Economic Growth and Inflation

Warsh’s interpretation of artificial intelligence is one of the most forward-looking aspects of his policy framework and one of the key features distinguishing him from his predecessors. It also serves as a core pillar of his strategic thinking on competition with China.

He explicitly states that AI is a powerful deflationary force, with its core value lying in its ability to significantly enhance social productivity. This, he argues, would allow the economy to achieve faster growth without triggering inflation. While this view has gained support from some in the technology sector, it also remains highly controversial and should be viewed from multiple perspectives.

Warsh has described the AI-driven productivity revolution as “the most significant wave of productivity enhancement in our lifetime.” He believes that if the US can successfully harness this wave, it can achieve a mutually reinforcing combination of high growth and low inflation, creating a “New Economy 2.0” development model.

Such a model would effectively offset China’s long-standing manufacturing cost advantages. By maintaining low domestic inflation and monetary stability, the US could continue attracting the global capital needed to support competition in the “AI century,” fundamentally reinforcing its economic leadership and gaining the initiative in the productivity race against China.

However, from a practical perspective, the explosive growth of the AI industry is also driving up prices for upstream raw materials such as rare earths and copper, while electricity costs continue to rise. This appears to contradict the argument that “AI brings deflation,” suggesting that Warsh’s view may underestimate the short-term supply shocks caused by technological advancement and may therefore be somewhat one-sided.

Streamlining the Fed by Reducing Functional Boundaries and Normalizing the Balance Sheet

Warsh believes that after the 2008 financial crisis, the Federal Reserve became trapped in a dilemma of excessive functional expansion by becoming overly involved in non-core areas such as climate change and social diversity. He plans to reduce the Federal Reserve’s Washington headquarters staff from 3,200 to around 2,000 employees.

Warsh has also long criticized the Federal Reserve’s current USD6.7 trillion balance sheet, arguing that excessive expansion distorts market signals and leads to resource misallocation. He has made clear that shrinking the balance sheet cannot be accomplished overnight, but the core objective is to reestablish interest rates as the primary tool of monetary policy. This would involve reducing the central bank’s active intervention in markets and avoiding the imbalances caused by the normalization of balance sheet tools.

As Warsh advocates for the Federal Reserve to divest from non-core functions and return to its core mission of “price stability,” the Chinese government is moving in the opposite direction. It is transforming the People’s Bank of China into a comprehensive tool integrating monetary policy, industrial policy and certain fiscal functions, while leveraging its balance sheet to promote the internationalization of the yuan. In Warsh’s view, this represents China’s strategic attempt to build a “parallel financial infrastructure,” with the primary goal of creating space for the yuan to operate independently of the US dollar system and gradually weaken the dollar’s global dominance.

Reconstructing Central Bank Independence

Regarding central bank independence, Warsh has proposed a view that departs from the Federal Reserve’s traditional rhetoric: “Independence must be earned through performance.” This perspective challenges the conventional belief that central bank independence is an inherent right. The core logic behind this argument is that a central bank’s independence derives from its ability to fulfill its core responsibilities.

When the Federal Reserve fails to deliver on its commitment to stable inflation, political intervention naturally follows. Conversely, if it focuses on its core duties and fulfills its mission precisely, it can genuinely achieve the goal of “keeping politics at bay” and rebuilding its credibility.

However, objectively speaking, Warsh’s views align closely with the current administration’s key policy goals of lowering interest rates and reducing regulation, raising market concerns about the possible re-emergence of a “Treasury-Fed Accord.”

Moreover, if the Federal Reserve’s policies become overly aligned with government demands, it could undermine the traditional notion of the Fed’s independence from politics and weaken its credibility in global financial markets. In the long run, this could be detrimental to the US dollar’s status as a reserve currency and could also weaken the credibility and effectiveness of US strategic competition policies toward China.

Regulatory Easing Focused on Small and Regional Banks to Alleviate Credit Constraints

Warsh plans to lead a large-scale deregulation effort in the banking sector. He argues that excessive regulatory burdens -- particularly those imposed on regional and small banks -- have severely restricted credit flows and market competition, inadvertently fueling inflation.

Specifically, Warsh is expected to revise the final implementation framework of Basel III, streamline compliance procedures for banks, reduce regulatory costs for small and medium-sized lenders, and eliminate regulatory constraints that suppress market dynamism.

It is important to note that these regulatory reforms could, in the short term, enhance the lending capacity of small and medium-sized banks in the US, stimulate private-sector innovation, and provide more funding support for the development of the AI industry, thereby strengthening America’s innovative advantage in the “productivity competition” with China.

However, in the long run, they could also increase risks within the financial system, underscoring the need for caution over the potential for financial instability resulting from deregulation.

The author of this article is the chief China economist at Nomura Holdings.

Editor: Emmi Laine