Fu Peng: "The Five Working Groups" Signal the Beginning of Walsh Reforms [Fu Peng Speaks - In-depth Article]

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"Five Working Groups": The Beginning of Warsh's Reform

The core of Kevin Warsh's first meeting and statement can be summarized as "The formal launch of the Five Working Groups Reform."

At the press conference after presiding over his first FOMC interest rate meeting, Warsh clearly stated: "I will establish five working groups focusing on five core areas in the practice of monetary policy."

In my view, the core areas covered by these five working groups are crucial—in fact, they represent the future adjustment directions for Federal Reserve policy in key areas.

01 Five Working Groups: The Start of Reform

In this meeting, Kevin Warsh made it clear to drastically streamline such market communication tools, as he believes they are no longer suitable for current monetary policy. Other than essential economic situation analysis, no further forward guidance will be provided.

As for the "dot plot" (the most closely watched part of the Summary of Economic Projections, SEP), it is certain to be abolished within this year. In the dot plot released this time, only 18 out of 19 policymakers submitted rate forecasts, leaving one slot vacant. Although it's unclear who specifically failed to submit or vote, widespread speculation points to Kevin Warsh.

He has publicly stated that, for him, submitting dot plot forecasts carries no real meaning for policy execution. This reflects his aversion to highly programmatic policy tools: he likened the dot plot to "a pencil with an eraser," arguing that such forward guidance creates "too much noise," limits policy flexibility, and distorts markets—as seen when aggressive rate hikes had to correct misjudgments about inflation in 2021–2022.

This precisely aligns with the five special working groups Warsh announced upon taking office, in particular the "Communications Working Group," which is responsible for reviewing the Fed's communication methods, including adjustments to the SEP (the dot plot's presentation, its weighting in decision-making, etc.).

In later remarks, Kevin Warsh also cited the "Data Working Group" as an example. The main intent is to continue promoting reform—that is, to adjust data sources and methodologies. Since the central bank currently relies largely on traditional surveys, the Data Working Group is putting forward recommendations to improve official statistics.

Through clear adjustments by the "Communications Working Group" and the role of the "Data Working Group," the market can easily understand the essence of the five working groups: to make substantial adjustments to the existing framework:

Communications Working Group: Review the Fed's communication approaches, including adjustments to the SEP/dot plot, to reduce "noise" from forward guidance and excessive official statements.
Balance Sheet Working Group: Evaluate the structure of bond holdings, advantages and alternatives of the ample reserves regime, and explore alternative frameworks for monetary policy implementation.
Data Source/Collection Working Group: Address data lag issues, evaluate new information sources and methodology improvements for more timely economic insights.
Productivity and Employment Working Group: Review the impact of AI and other general-purpose technologies on productivity and the labor market, as well as implications for Fed policy.
Inflation Framework Working Group: Re-examine the drivers of inflation and approaches to price stability (some reports indicate the 2% target itself may not be directly evaluated, but the whole framework will be reviewed), meaning significant adjustments to the driving factors behind inflation are possible.

02 What are the Core Points of Disagreement?

Another point worth noting is that one of the working groups will research a long-standing core issue of dispute between Warsh and the Fed. Although it is not clearly stated which area this is, it will study and review the "ample reserves regime" and possible alternatives. This is unequivocally the core point of disagreement between Warsh and the Fed (especially regarding post-crisis policy paths).

The ample reserves system, in the post-crisis era, is superior to the traditional scarce reserves framework in terms of interest rate control precision and financial stability. Through QT, the Fed successfully moved reserves down from "excessive" to "minimally ample" levels (with a phased transition expected to complete around the end of 2025).

However, the costs related to this framework (balance sheet losses, market distortions, normalization difficulty) are real and cannot be ignored. The framework is not a "free lunch"; ongoing trade-offs are required among control, stability, and efficiency/costs.

Warsh, who served as a Fed governor from 2005 to 2011, has long expressed dissatisfaction with the Fed’s ever-growing balance sheet and has controversially argued that the Fed holds too many bonds, negatively impacting the economy. He believes the Fed’s large bond purchases during crises distorted market signals and forced the Fed to make decisions that should have been left to elected officials. He has repeatedly argued publicly for significant, orderly balance sheet reduction and a return to a smaller and more traditional framework, rather than maintaining the current ample reserves paradigm. This marks a longstanding structural divergence from the framework the Fed has used since 2008 (especially after its formalization in 2019), and is considered the core of one of his "longstanding policy criticisms" under the reform agenda.

Although many current Fed officials and economists hold different views—arguing that the current framework works well for short-term rate control and that claims of market distortion are unfounded—at this meeting, Warsh, while leaving "room" for the current balance sheet policy ("the committee reaffirmed the policy of maintaining ample reserves in the banking system"), made clear that the next work of the five groups, their research and review, as well as his plan to involve more market professionals (from outside of traditional economics), is the real key. Whether to maintain the Fed’s "minimally adequate size" strategy (ample reserves + management of reserve purchases), or to return to a smaller/more traditional framework, rather than continuing the current ample reserves paradigm, will become clear over the next six months as the Balance Sheet Working Group’s evaluations influence the pace of balance sheet reduction and monetary policy implementation;

03 Reform Timeline

Warsh mentioned in his remarks: “A change in leadership is an appropriate time to review overall operation and reassert our mission.” This statement likely refers to a major framework adjustment around the US election. Based on the timelines he mentioned for the working groups' tasks and plans, this intent is confirmed by the schedule.

The intent is clear: These working groups will be quickly launched in the coming weeks, provide more information and framework views gradually by the third quarter (fall), and aim to complete most of the work by the end of the year.

Importantly, these independent working groups will invite outstanding professionals from both inside and outside the field of economics to participate. "Inside and outside" here refers not only to conventional economists but also to non-traditional talent. Judging from current US government staffing trends in key positions, the latter refers mainly to non-academic professionals active in the markets. Through this "disruptive restructuring," the original rigid organizational framework will be broken, making it more relevant to actual market conditions. For example, Treasury Secretary Yellen's background in hedge funds—personnel from such backgrounds are steering organizational frameworks toward greater market orientation.

This is also confirmed by Kevin Warsh's subsequent statements: he is closer to the market and believes in market forces, rather than relying on programmatic policy tools. For instance, with "forward guidance," he has clearly expressed his aversion to such highly programmatic policy instruments.

Five working groups, five main directions, with the core still reflecting Warsh’s overall philosophy of "framework restructuring and return to fundamentals."

Risk Warning and DisclaimerThe market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account individual users' special investment objectives, financial situation, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable to their particular circumstances. Investing accordingly is at your own risk. ```