Hawks to Doves? Warsh at the Fed: Can Balance Sheet Reduction and Interest Rate Cuts Go Hand in Hand?
2026-04-20 17:26:09
As the youngest Federal Reserve governor in history, serving from 2006 to 2011, Warsh has long been known as a "tightening hawk," and has consistently criticized the Fed for excessive balance sheet expansion and excessive policy intervention after the crisis.
However, in recent years his stance has clearly shifted, and he has begun to publicly support interest rate cuts. This contradictory policy orientation has led the market to speculate on the direction of the Federal Reserve under his leadership—in particular, whether he will introduce a combination of "balance sheet reduction and interest rate cuts" to loosen restrictions on the US government's debt issuance and open up room for fiscal policy has become a core concern of the global financial market.
Warsh's eligibility to serve as Federal Reserve Chairman still needs to pass the "big test" of his nomination hearings on the Senate Banking Committee. This is also the first time that his policy proposals have been publicly and comprehensively questioned, with the core disputes focusing on three major dimensions.
First, the issue of the Federal Reserve's independence . Trump has explicitly asked the new chairman to push for interest rate cuts. How to balance political demands with the central bank's independent decision-making principles will be a key point of questioning at the hearing.
Secondly, the contradiction between inflation and interest rate paths : the CPI rose to 3.3% year-on-year in March, a near two-year high, coupled with the Middle East geopolitical conflict pushing up energy inflation, making the window for interest rate cuts highly questionable;
Third, there are concerns about conflicts of interest and investigative controversies. Some Republican lawmakers are temporarily not supporting his nomination because the Justice Department’s investigation into the renovation of the Federal Reserve headquarters is still ongoing. Furthermore, there are concerns about conflicts of interest arising from Warsh’s hundreds of millions of dollars in personal assets. Although he has promised to sell the relevant assets after being appointed to avoid risks, this will still be a focus of questioning.
However, thanks to Trump's strong support and the backing of some forces on Wall Street, the probability of it being approved by the Senate is relatively high. Only the process may be delayed. If it is not approved before Powell's term ends in May, the latter will assume office temporarily.
If Warsh takes office smoothly, his core policies will revolve around "exchanging quantitative tightening for easing." This approach, which differs from the traditional idea that "interest rate cuts inevitably lead to quantitative tightening," may provide key logical support for the implementation of a combination of "quantitative tightening + YCC + interest rate cuts."
For a long time, Warsh has consistently advocated for the Federal Reserve to return to its role as a "small central bank," arguing that the current $6.7 trillion balance sheet is a "bloated product" left over from the crisis, excessively distorting financial pricing and squeezing out private investment space.
He explicitly opposed the multiple rounds of large-scale quantitative easing since 2008, criticized the Federal Reserve's balance sheet as the core tool for market intervention, and questioned the rationale for expanding the balance sheet to nearly $9 trillion during the pandemic.
Even though the Federal Reserve stopped reinvesting assets and started passive balance sheet reduction at the end of last year, Warsh still publicly criticized the insufficient力度 (intensity/strength) and emphasized that "deep balance sheet reduction is the prerequisite for long-term interest rate cuts"—in his view, the policy space released by balance sheet reduction can be transformed into interest rate cut dividends, which can precisely benefit residents and small and medium-sized enterprises, rather than mainly flowing to large institutions as in the past.
This approach provides a feasible option for the combination of "interest rate cuts + YCC".
Traditional YCC (Yield Curve Control) requires the central bank to directly purchase long-term government bonds and suppress long-term interest rates, which is often accompanied by balance sheet expansion and can easily exacerbate the risks of inflation and asset bubbles.
But Warsh's approach is "simultaneous balance sheet reduction and interest rate cuts, replacing overall easing with structural easing": on the one hand, promoting the orderly contraction of the balance sheet, gradually reducing holdings of long-term treasury bonds and MBS acquired during the pandemic, and withdrawing excess liquidity;
On the other hand, in response to the government's bond issuance needs, the Federal Reserve implements implicit YCC through targeted operations—when the Treasury issues new long-term Treasury bonds, the Fed moderately slows down the pace of selling assets of the corresponding maturity, or adjusts market liquidity through repurchase agreements to prevent long-term interest rates from rising sharply due to government bond issuance, or reforms the reserve requirement ratio to make banks the main purchasers of Treasury bonds. This stabilizes the cost of Treasury bond issuance, does not significantly expand the size of the Fed's balance sheet, and also increases the Fed's regulatory tools, maintaining the central bank's independence.
While Warsh's proposal to cut interest rates has the political backing of Trump and aligns with his logic of "trading quantitative tightening for easing," its implementation still faces the dual constraints of inflation and the Fed's internal decision-making.
From the perspective of the inflation environment, the window for interest rate cuts has not yet opened. In March, the US CPI rose to 3.3% year-on-year, a new high in nearly two years, and the month-on-month growth rate was the fastest since 2022. Coupled with the continued rise in energy prices due to geopolitical conflicts in the Middle East, the risk of energy-imported inflation is still brewing.
Treasury Secretary Bessant has made it clear that "now is not the time to cut interest rates," advocating that the Federal Reserve should prioritize observing the inflationary impact of geopolitical conflicts. This is consistent with the consensus of most officials within the Federal Reserve—including Christopher Waller, a previously dovish governor, most members advocate "holding back," and Chicago Fed President Austan Goolsby even bluntly stated that "the conditions for cutting interest rates may not be met throughout 2026."
From the perspective of the decision-making mechanism, the Federal Reserve adopts a collective decision-making system, and the majority support of the 12 FOMC members is a necessary condition for cutting interest rates.
Although Walsh, as chairman, has the power to set the meeting agenda, he does not have the power to unilaterally adjust interest rates. If he wants to push for a rate cut, he must convince enough members to agree with his core judgment that "AI-driven productivity gains will curb inflation"—that is, technological progress can achieve high growth and low inflation simultaneously, thus creating room for a rate cut.
Therefore, even if Warsh takes office, interest rate cuts will most likely be a "gradual and delayed" operation: first, stabilize internal consensus through "wait and see assessment", and then, after geopolitical conflicts ease and inflation shows signs of sustained decline, work with members with similar positions to push for a small interest rate cut, possibly 2-3 times a year, with each adjustment being 25 basis points.
If the combination of "interest rate cuts + implicit YCC + structural easing" can be implemented, it will directly open up space for the US government to issue bonds and expand fiscal policy, forming a linkage effect of "monetary easing - fiscal stimulus".
On the one hand, the combination of interest rate cuts and yield curve control (YCC) will significantly reduce the cost of government bond issuance.
The current U.S. federal government debt has exceeded $34 trillion, and the pressure of interest payments continues to increase. The stability of long-term interest rates is crucial for the government's sustainable debt issuance.
Walsh's proposed implicit YCC (Yield Control) mechanism, by adjusting the pace of balance sheet reduction and liquidity tools, can stabilize the yields of 10-year and 30-year Treasury bonds at relatively low levels, avoiding interest rate spikes caused by large-scale bond issuance. This would reduce the financing costs of newly issued Treasury bonds and alleviate the interest burden of existing debt, giving the government more room to issue bonds on a larger scale and at a greater frequency.
On the other hand, structural easing will empower fiscal policy. Warsh's advocacy of "releasing resources through balance sheet reduction and shifting to interest rate cuts" is not a traditional form of aggregate easing, but rather a more precise guidance of liquidity—reducing the financing costs of residents and businesses through interest rate cuts, thereby boosting economic vitality and the tax base.
At the same time, the assets sold during the Federal Reserve's balance sheet reduction process are mainly those related to large institutions that were acquired during the crisis, reducing the crowding-out effect on the private sector and making room for fiscal policy to take effect.
For example, the government can increase spending on infrastructure and people's livelihoods by issuing new government bonds, while a loose monetary environment and stable interest rates will reduce the "crowding-out effect" of fiscal policy and improve the efficiency of policy transmission.
Although the combination of "interest rate cuts + YCC + easing" has both theoretical logic and practical necessity, its implementation still faces three core obstacles that may weaken its supporting effect on fiscal expansion.
First, it is difficult to reach a consensus within the Federal Reserve. There are members of the FOMC who oppose the YCC, believing that it will excessively intervene in market pricing and erode the central bank's independence.
Furthermore, some committee members expressed doubts about the feasibility of "simultaneous reduction of balance sheet and interest rate cuts," worrying that too rapid a reduction in balance sheet could lead to a sudden halt in liquidity and a credit crunch, which would instead constrain economic and fiscal efforts.
Secondly, the path of fiscal-money coordination is hindered. Warsh's proposed "Federal Reserve-Treasury coordination" model is similar to the "fiscal-money agreement" during the new policy era, but this idea has been publicly rejected by Treasury Secretary Bessant. Without the cooperation of the Treasury, the Fed's implicit YCC operation will be difficult to accurately match the government's debt issuance pace, and the policy effect will be greatly reduced.
Third, there are risks from the external environment and recurring inflation. If geopolitical conflicts in the Middle East escalate, leading to a sharp rise in energy prices, or if a tight labor market pushes up wage inflation, the Federal Reserve may be forced to pause interest rate cuts or even restart interest rate hikes. The combined logic of "interest rate cuts + YCC + easing" will collapse directly, and the government's debt issuance costs and fiscal expansion space will also be limited.
If Warsh successfully takes the helm of the Federal Reserve, maintaining the Fed's independence while simultaneously cutting interest rates and easing monetary policy is not wishful thinking, but a natural extension of his "quantitative tightening in exchange for easing" policy logic. One of the core objectives is to loosen restrictions on government debt issuance and strengthen fiscal policy capabilities.
However, the implementation of this combination requires overcoming three major constraints: internal decision-making, financial and monetary coordination, and inflation fluctuations. Ultimately, it is more likely to present a compromise of "moderate interest rate cuts + balance sheet reduction + structural easing".
For the market, it is crucial to pay close attention to the policy statements made at the nomination hearings, changes in the composition of the FOMC, and the evolution of inflation and geopolitical conflicts—these factors will collectively determine the extent of the Fed's policy shift, thereby affecting the actual scope of US fiscal expansion and the direction of global financial markets.
With balance sheet reduction as the core, coupled with regulatory reforms and monetary policy tools, this approach addresses the inefficiency of the financial system, creates space for fiscal and economic growth, and upholds the bottom line of central bank independence.
However, in recent years his stance has clearly shifted, and he has begun to publicly support interest rate cuts. This contradictory policy orientation has led the market to speculate on the direction of the Federal Reserve under his leadership—in particular, whether he will introduce a combination of "balance sheet reduction and interest rate cuts" to loosen restrictions on the US government's debt issuance and open up room for fiscal policy has become a core concern of the global financial market.
Uncertainties surround the path to office: nomination hearings and key points of contention.
Warsh's eligibility to serve as Federal Reserve Chairman still needs to pass the "big test" of his nomination hearings on the Senate Banking Committee. This is also the first time that his policy proposals have been publicly and comprehensively questioned, with the core disputes focusing on three major dimensions.
First, the issue of the Federal Reserve's independence . Trump has explicitly asked the new chairman to push for interest rate cuts. How to balance political demands with the central bank's independent decision-making principles will be a key point of questioning at the hearing.
Secondly, the contradiction between inflation and interest rate paths : the CPI rose to 3.3% year-on-year in March, a near two-year high, coupled with the Middle East geopolitical conflict pushing up energy inflation, making the window for interest rate cuts highly questionable;
Third, there are concerns about conflicts of interest and investigative controversies. Some Republican lawmakers are temporarily not supporting his nomination because the Justice Department’s investigation into the renovation of the Federal Reserve headquarters is still ongoing. Furthermore, there are concerns about conflicts of interest arising from Warsh’s hundreds of millions of dollars in personal assets. Although he has promised to sell the relevant assets after being appointed to avoid risks, this will still be a focus of questioning.
However, thanks to Trump's strong support and the backing of some forces on Wall Street, the probability of it being approved by the Senate is relatively high. Only the process may be delayed. If it is not approved before Powell's term ends in May, the latter will assume office temporarily.
The core policy logic: a unique path of "trading quantitative easing for quantitative tightening".
If Warsh takes office smoothly, his core policies will revolve around "exchanging quantitative tightening for easing." This approach, which differs from the traditional idea that "interest rate cuts inevitably lead to quantitative tightening," may provide key logical support for the implementation of a combination of "quantitative tightening + YCC + interest rate cuts."
For a long time, Warsh has consistently advocated for the Federal Reserve to return to its role as a "small central bank," arguing that the current $6.7 trillion balance sheet is a "bloated product" left over from the crisis, excessively distorting financial pricing and squeezing out private investment space.
He explicitly opposed the multiple rounds of large-scale quantitative easing since 2008, criticized the Federal Reserve's balance sheet as the core tool for market intervention, and questioned the rationale for expanding the balance sheet to nearly $9 trillion during the pandemic.
Even though the Federal Reserve stopped reinvesting assets and started passive balance sheet reduction at the end of last year, Warsh still publicly criticized the insufficient力度 (intensity/strength) and emphasized that "deep balance sheet reduction is the prerequisite for long-term interest rate cuts"—in his view, the policy space released by balance sheet reduction can be transformed into interest rate cut dividends, which can precisely benefit residents and small and medium-sized enterprises, rather than mainly flowing to large institutions as in the past.
This approach provides a feasible option for the combination of "interest rate cuts + YCC".
Traditional YCC (Yield Curve Control) requires the central bank to directly purchase long-term government bonds and suppress long-term interest rates, which is often accompanied by balance sheet expansion and can easily exacerbate the risks of inflation and asset bubbles.
But Warsh's approach is "simultaneous balance sheet reduction and interest rate cuts, replacing overall easing with structural easing": on the one hand, promoting the orderly contraction of the balance sheet, gradually reducing holdings of long-term treasury bonds and MBS acquired during the pandemic, and withdrawing excess liquidity;
On the other hand, in response to the government's bond issuance needs, the Federal Reserve implements implicit YCC through targeted operations—when the Treasury issues new long-term Treasury bonds, the Fed moderately slows down the pace of selling assets of the corresponding maturity, or adjusts market liquidity through repurchase agreements to prevent long-term interest rates from rising sharply due to government bond issuance, or reforms the reserve requirement ratio to make banks the main purchasers of Treasury bonds. This stabilizes the cost of Treasury bond issuance, does not significantly expand the size of the Fed's balance sheet, and also increases the Fed's regulatory tools, maintaining the central bank's independence.
Constraints on Implementing Interest Rate Cuts: A Dual Test of Inflation and Internal Decision-Making
While Warsh's proposal to cut interest rates has the political backing of Trump and aligns with his logic of "trading quantitative tightening for easing," its implementation still faces the dual constraints of inflation and the Fed's internal decision-making.
From the perspective of the inflation environment, the window for interest rate cuts has not yet opened. In March, the US CPI rose to 3.3% year-on-year, a new high in nearly two years, and the month-on-month growth rate was the fastest since 2022. Coupled with the continued rise in energy prices due to geopolitical conflicts in the Middle East, the risk of energy-imported inflation is still brewing.
Treasury Secretary Bessant has made it clear that "now is not the time to cut interest rates," advocating that the Federal Reserve should prioritize observing the inflationary impact of geopolitical conflicts. This is consistent with the consensus of most officials within the Federal Reserve—including Christopher Waller, a previously dovish governor, most members advocate "holding back," and Chicago Fed President Austan Goolsby even bluntly stated that "the conditions for cutting interest rates may not be met throughout 2026."
From the perspective of the decision-making mechanism, the Federal Reserve adopts a collective decision-making system, and the majority support of the 12 FOMC members is a necessary condition for cutting interest rates.
Although Walsh, as chairman, has the power to set the meeting agenda, he does not have the power to unilaterally adjust interest rates. If he wants to push for a rate cut, he must convince enough members to agree with his core judgment that "AI-driven productivity gains will curb inflation"—that is, technological progress can achieve high growth and low inflation simultaneously, thus creating room for a rate cut.
Therefore, even if Warsh takes office, interest rate cuts will most likely be a "gradual and delayed" operation: first, stabilize internal consensus through "wait and see assessment", and then, after geopolitical conflicts ease and inflation shows signs of sustained decline, work with members with similar positions to push for a small interest rate cut, possibly 2-3 times a year, with each adjustment being 25 basis points.
A combination of measures and fiscal expansion: the potential for interaction between government bond issuance and fiscal policy.
If the combination of "interest rate cuts + implicit YCC + structural easing" can be implemented, it will directly open up space for the US government to issue bonds and expand fiscal policy, forming a linkage effect of "monetary easing - fiscal stimulus".
On the one hand, the combination of interest rate cuts and yield curve control (YCC) will significantly reduce the cost of government bond issuance.
The current U.S. federal government debt has exceeded $34 trillion, and the pressure of interest payments continues to increase. The stability of long-term interest rates is crucial for the government's sustainable debt issuance.
Walsh's proposed implicit YCC (Yield Control) mechanism, by adjusting the pace of balance sheet reduction and liquidity tools, can stabilize the yields of 10-year and 30-year Treasury bonds at relatively low levels, avoiding interest rate spikes caused by large-scale bond issuance. This would reduce the financing costs of newly issued Treasury bonds and alleviate the interest burden of existing debt, giving the government more room to issue bonds on a larger scale and at a greater frequency.
On the other hand, structural easing will empower fiscal policy. Warsh's advocacy of "releasing resources through balance sheet reduction and shifting to interest rate cuts" is not a traditional form of aggregate easing, but rather a more precise guidance of liquidity—reducing the financing costs of residents and businesses through interest rate cuts, thereby boosting economic vitality and the tax base.
At the same time, the assets sold during the Federal Reserve's balance sheet reduction process are mainly those related to large institutions that were acquired during the crisis, reducing the crowding-out effect on the private sector and making room for fiscal policy to take effect.
For example, the government can increase spending on infrastructure and people's livelihoods by issuing new government bonds, while a loose monetary environment and stable interest rates will reduce the "crowding-out effect" of fiscal policy and improve the efficiency of policy transmission.
Implementation Obstacles: Uncertainties Under Triple Constraints
Although the combination of "interest rate cuts + YCC + easing" has both theoretical logic and practical necessity, its implementation still faces three core obstacles that may weaken its supporting effect on fiscal expansion.
First, it is difficult to reach a consensus within the Federal Reserve. There are members of the FOMC who oppose the YCC, believing that it will excessively intervene in market pricing and erode the central bank's independence.
Furthermore, some committee members expressed doubts about the feasibility of "simultaneous reduction of balance sheet and interest rate cuts," worrying that too rapid a reduction in balance sheet could lead to a sudden halt in liquidity and a credit crunch, which would instead constrain economic and fiscal efforts.
Secondly, the path of fiscal-money coordination is hindered. Warsh's proposed "Federal Reserve-Treasury coordination" model is similar to the "fiscal-money agreement" during the new policy era, but this idea has been publicly rejected by Treasury Secretary Bessant. Without the cooperation of the Treasury, the Fed's implicit YCC operation will be difficult to accurately match the government's debt issuance pace, and the policy effect will be greatly reduced.
Third, there are risks from the external environment and recurring inflation. If geopolitical conflicts in the Middle East escalate, leading to a sharp rise in energy prices, or if a tight labor market pushes up wage inflation, the Federal Reserve may be forced to pause interest rate cuts or even restart interest rate hikes. The combined logic of "interest rate cuts + YCC + easing" will collapse directly, and the government's debt issuance costs and fiscal expansion space will also be limited.
Conclusion
If Warsh successfully takes the helm of the Federal Reserve, maintaining the Fed's independence while simultaneously cutting interest rates and easing monetary policy is not wishful thinking, but a natural extension of his "quantitative tightening in exchange for easing" policy logic. One of the core objectives is to loosen restrictions on government debt issuance and strengthen fiscal policy capabilities.
However, the implementation of this combination requires overcoming three major constraints: internal decision-making, financial and monetary coordination, and inflation fluctuations. Ultimately, it is more likely to present a compromise of "moderate interest rate cuts + balance sheet reduction + structural easing".
For the market, it is crucial to pay close attention to the policy statements made at the nomination hearings, changes in the composition of the FOMC, and the evolution of inflation and geopolitical conflicts—these factors will collectively determine the extent of the Fed's policy shift, thereby affecting the actual scope of US fiscal expansion and the direction of global financial markets.
With balance sheet reduction as the core, coupled with regulatory reforms and monetary policy tools, this approach addresses the inefficiency of the financial system, creates space for fiscal and economic growth, and upholds the bottom line of central bank independence.
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