Kevin Warsh, who is President Trump’s nominee to chair the Federal Reserve Board, is known as an inflation hawk. And the president is well known to prefer low interest rates. Is there a plausible inflation-hawkish case for cutting interest rates when inflation is running above the Fed’s target? There are certainly off-beat economic theories that might justify cutting rates now, but also a couple of respectable views—though not the standard economic model within the economics profession.
The Standard Economic Model Of Interest Rates And Inflation
What if we push spending in the economy to grow faster than the growth rate of productive capacity? We would see the classical definition of inflation: too much money chasing too few goods (and services). Low interest rates stimulate spending on new residential construction, big-ticket consumer goods such as cars and boats, as well as business capital expenditures.
How fast can we push spending up? Productive capacity is harder to measure than spending, but we do have data on the size of the labor force and productivity per worker. The labor force can be predicted with decent accuracy, while labor productivity historically has grown by about two percent per year.
Cutting interest rates would simulate spending. And productive capacity is now growing less rapidly than in the recent past because the labor force is barely increasing in size. Tough immigration enforcement has combined with aging baby boomers to prevent the number of workers from growing at past rates. So the standard model says that cutting interest rates is contrary to an anti-inflation stance.
Interest Rates And Inflation In A Productivity Boom
Productivity growth varies over time, and accelerating output per worker implies a supply increase. Boosting spending through lower interest rates will let demand keep up with supply. Productivity increases due mostly to technological changes, with lesser effects from the composition of the workforce and regulations affecting business.
The story that would most justify cutting interest rates in 2026 was Alan Greenspan’s decision 30 years ago to keep interest rates level despite rising inflation, and then to actually cut rates in 1998. He anticipated productivity gains coming from software development and supply-chain improvements. Kevin Warsh, if confirmed as Fed chair, could well argue that AI’s stimulus to productivity justifies—indeed, demands—lower interest rates to keep spending increases in line with total output gains.
Fiscal Theory Of The Price Level And Interest Rate Cuts
A minority viewpoint argues that low interest rates do not cause inflation, and raising interest rates does not limit inflation. Rather, the price level is determined by the federal budget deficit. When the U.S. treasury has to borrow more money, especially more money than can be repaid at current tax rates, prices will rise until the inflation-adjusted government debt matches upcoming inflation-adjusted tax revenue.
If inflation is caused by federal government deficits, then cutting rates would lower the Treasury’s interest expense, and thus might reduce inflation. Most economists are skeptical of the view, but the data are hard to interpret. Quite often expansive monetary policy occurs at the same time as large budget deficits.
Political Forces In The Fed’s Interest Rate Policy
Members of the Fed’s policy-making committee would like make interest rate decisions while ignoring politics. That is often impossible. President Trump clearly talks to candidates for the Federal Reserve Board about his interest rate preference. The regional Federal Reserve Bank presidents know the White House preference, and some might want to curry favor with him. But they all value their independence.
Even if Kevin Warsh pushed hard for interest rate cuts, it’s doubtful that the board would go along. And if they did vote to lower rates, it would more likely be for one or two small cuts, throwing the president a bone.
A Forecast Of Interest Rates For 2026-2027
I expect the Fed to not change short-term interest rates in 2026, with small drops possible late in 2027. The chief alternative is two quarter-point cuts this year, then no more. In no case would drops of a full percentage point seem likely. To see really strong interest rate cuts, artificial intelligence would need to noticeably boost productivity across wide swaths of the economy. That is quite likely at some point in the future, but 2026 seems too soon.
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