Viewpoints: July 2026

Fed Chair Warsh's term has begun with some challenges, and it's still uncertain how he intends to handle monetary policy. Forecasting plays a vital role in effective policymaking, yet Mr. Warsh has not provided his forecast and does not support maintaining the practice of delivering quarterly forecasts.

Former Fed Chairman Mr. Greenspan was highly skilled in making monetary policy decisions, with one of his key strengths being his experience as a forecaster before becoming the Fed Chair. Mr. Greenspan dedicated countless hours to analyzing economic data and financial markets to understand future economic and financial trends. Although his forecasts were not always spot-on, they were sufficiently accurate to guide monetary policy, often preemptively.

Forecasting is not easy; I know, as I did it for almost 40 years on Wall Street. Having worked at the Department of Commerce, I studied and learned the economic data, what was important for forecasting, and what was less so. Utilizing certain macro variables to set growth parameters was extremely beneficial, allowing the economy to "fill in the blanks" or composition of growth for each quarter. Every forecast needs to be cross -checked as much as possible, and it was always important to make sure what appeared to be occurring on the product side of the economy was also true on the income side (or jobs & wages, and profits).

The Bureau of Economic Analysis (BEA) once released a handbook of cyclical indicators, and one of my reliable indicators was "liquidity flows." I quickly realized that "money drives the economy." BEA no longer publishes this book, and the Fed stopped publishing data that was used to estimate liquidity flows.

One of Mr. Warsh's task force's tasks is to "evaluate new information sources and consider methodological changes to improve data gathering, with the aim of giving policymakers more accurate, relevant, contemporaneous, and, perhaps most important, actionable information on the state of our economy." This is a "nothing burger".

Today, the Fed and analysts possess ample government and private sector data, along with surveys, to make well-informed evaluations of current and future economic conditions. The Fed doesn't require additional data sources; instead, it needs to comprehend the existing data better and revive some of the crucial financial series it previously discontinued.

Mr. Warsh's critique of the Fed's economic projections is warranted. The Fed's forecasts consistently suggest that policymakers will meet their inflation mandate, if not in the upcoming year, then certainly within two years. However, policymakers should have recognized by this point that the economy and inflation operate independently of their predictions, making it crucial for them to comprehend the reasons why before policy errors happen.

The quicker Mr. Warsh "learns to forecast," the sooner he can make informed decisions regarding monetary policy.

The world is investing on an extraordinary scale. The question is whether that investment expands productive capacity or merely offsets a more constrained world.

The global economy is entering its strongest investment cycle for a generation. Artificial intelligence, the energy transition, geopolitical fragmentation and higher defence spending are all driving capital expenditure. Unlike previous cycles, however, these forces increasingly compete for the same scarce inputs: energy, grids, critical minerals, water and skilled labour.

As expected, the trade war is making a comeback and will likely be as disruptive to the economy as last year.

Trump Always Tries Again (TATA)

For the last three months or so the trade war had been bumped out of the headlines. This is partly because courts reversed some of the Administration’s original tariffs, and partly due to the all-consuming focus on the Iran War. Meanwhile, behind the scenes the Administration has being doing the prep work for “Section 301” tariffs. These take time to implement because they first require an investigation to prove “unfair” practices.

Those investigations are now bearing fruit. Not surprisingly, the Administration has defined “unfair” in the broadest way possible. Brazil has been slapped with 25% tariffs due to six kinds of practices: an unfair payments system, digital and tech policies, agricultural barriers, weak protection of intellectual property, and illegal deforestation. President Trump is has threatened a 100% tariff on countries that levy a tax on U.S. companies offering digital services, and a separate 100% tariff on generic pharmaceuticals.

Several other fights have escalated. At the start of the month, the US decided not to ratify the USMCA, forcing new negotiations. The US is also threatening 50% tariffs on, Canada due to provincial bans on US alcohol, auto tariffs and quotas, and dairy restrictions. There is a bill in Congress that would give the President the power to put a tariff on any country buying Russian energy, including the EU.

However, the biggest threat is being justified by “unfair” weak enforcement of labor laws. US trade officials have drawn list of 59 countries countries that either have weak enforcement of labor laws or trade with countries that have weak enforcement. The later means that a vast majority of US imports could be impacted by this definition of “unfair “ trade practices. The list includes Australia, Brazil, Canada, the European Union, India Japan, Mexico, Norway, Singapore, South Korea, Switzerland, and the UK. The irony here is that by this definition the US should also be on this list because it trades with many of the same countries with weak labor law enforcement.

Digging in for a long fight

Not only is there a flood of actions in the pipeline, but there are three reasons to expect long, ugly fights. First, prior agreements have left a lot of unfinished business. For example, some included promises of big investment in the US, most of which hasn’t happened. Other deals are up in air due to similarly vague, hard to achieve demands or because the original US tariff threat no longer exists.

Second, some of the Administration’s demands are simply unreasonable. Why would countries unilaterally accept tariffs based on “unfair labor” enforcement when the US has the same violations? In other instances, the US is effectively asking countries to ruin their economy by out-source key domestic industries—like Canadian autos or Taiwanese chips—to the US. It is also a violation of the balance of payments identity for US trading partners to both reduce their trade surplus and increase net capital flows. The two move up and down together as the capital flows finance the deficit.

Third, leaders in other countries are under intense popular pressure to push back against US demands. They’ve seen that acceding to US demands only encourages more demands. Surveys from Pew Research show the dramatic drop in outside views of the US (chart), As the last two columns show, the median view of the US is now worse than the median view of China! Canada has taken the lead in pushing back against the US, but Europe is close behind. The upshot is that new negotiations will likely be even more intense than last Spring.

To my thinking, the surefire marker for the adoption of artificially intelligent (AI) “agents” is a decline in labor’s share of income. Here’s the logic in terms of production theory.

When I learned Solow growth accounting, the constancy of labor’s share of income was an accepted “stylized” economic fact. Cobb and Douglas demonstrated that if inputs are paid their marginal product in competitive factor markets, the constancy of labor’s share was consistent with a unitary elasticity of substitution between capital and labor. The logic was easy to grasp. A decline in the cost of capital relative to the wage rate encouraged a proportionate increase in ratio of capital to labor. Therefore, payments made to capital, relative to payments made to labor, remained unchanged.

AI agents are near-perfect substitutes for workers in certain occupations. Hence, the introduction of AI agents raises the overall elasticity of substitution between capital and labor relative to the traditional unitary value. At the same time, the cost of AI agents, reflected in the price per “token” in LLMs, is falling rapidly. Given the high elasticity of substitution between AI agents and certain workers, the rapid decline in the relative cost of AI agents encourages an increase in the ratio of capital to labor that is more than proportionate to the decline in the relative cost of capital. Consequently, capital’s share of income rises, while labor’s share declines.

After remaining fairly constant for decades following WWII, labor’s share fell unevenly between 2000 and 2022 by approximately 8 percentage points, from 69% to 61%. A plausible explanation of that decline was the initial emergence of agentic capital as the dot-com era evolved. Today there’s a widespread expectation that surging investment in AI will perpetuate this decline, perhaps dramatically. Maybe so, but it hasn’t happened yet.

The chart shows the recent quarterly history (through 2026 Q1) of labor’s share of income in the private nonfarm business sector, adjusted to exclude sectoral taxes on production and imports from the denominator. This exclusion, required by theory, allows that revenues from “indirect” taxes are not received by producers, and therefore not allocable to either capital or labor. When calculating “labor share” for its report on productivity and costs, the Bureau of Labor Statistics doesn’t make this adjustment. However, given the recent surge in customs duties, almost all of which are levied on private nonfarm business, the correction is important.

Perhaps aggregation conceals nascent effects in vulnerable sectors. Perhaps it will take more time for the ongoing “AI buildout” to affect the distribution of income noticeably in any sector. Perhaps the data will be revised. Be that as it may, more three and one half years after the introduction of ChatGPT in November of 2022, there has been no decline in labor’s share of income when correctly measured.

Europe entered the latest energy shock from a weaker position than it occupied before the 2025 global tariff shock. Unlike much of Asia, its exporters have yet to regain momentum and economic growth has slowed. First-quarter GDP data underline the divergence. Euro-area output expanded by only 0.8% year on year, weaker than at the end of last year and below the pace recorded a year earlier. By contrast, growth accelerated in the United States, Korea, Taiwan and China, while Japan broadly held steady (Figure1). Europe therefore enters the latest period of geopolitical uncertainty with less economic momentum than many of its major competitors, leaving businesses and policymakers with less room to absorb further shocks.

The Federal Reserve instituted the payment of interest on reserves on October 15, 2008, during the Great Financial Crisis. The motivating factor for this was that the federal funds rate was trading below the FOMC’s target rate. Banks had greatly increased their borrowing from the Federal Reserve. This created excess reserves (reserves in excess of then required reserves) in the banking system. These zero-yielding excess reserves put downward pressure on the federal funds rate. In order to induce banks to hold excess reserves and, thus, prevent the federal funds rate from falling below the FOMC’s target-rate level, the Federal Reserve began paying interest on reserves. By December 17, 2008, the FOMC had reduced the lower-limit of its target federal funds to zero. So, the Federal Reserve could have ceased paying interest on reserves because the FOMC’s target-level of federal funds rate was at zero, a level at which the actual federal funds rate could not fall below. Yet, the Federal Reserve persisted in paying interest of reserves.

The FOMC began raising its FOMC target-level of the federal funds rate above effective zero in December 2015. Yet the Federal Reserve persisted in paying interest on reserves, which it does today with a FOMC target level of the federal funds rate at 3.625%. In February 2009, the FOMC engaged in the first of a series of Quantitative Easing (QE) operations whereby the Federal Reserve added large quantities of securities to its outright holdings, culminating in the largest QE operation in 2020 during the Covid pandemic. On April 1, 2020, the Federal Reserve eliminated reserve requirements on banks. With the massive amounts of reserves created by the Federal Reserve since 2009 and with the elimination of reserve requirements in 2020, how is the FOMC able to maintain the federal funds rate above zero? It does so by the artificially-created demand for reserves resulting from the payment of interest on reserves by the Federal Reserve.

If Chairman Warsh wishes to reduce the size of the Federal Reserve’s balance sheet, I suggest that the Federal Reserve cease paying interest on reserves. Banks’ demand for reserves would fall significantly (but not to zero). This would enable the Federal Reserve to offload large quantities of securities in order to drain off the “excess” and unwanted supply of reserves. If the FOMC insists on continuing to conduct monetary policy through the federal funds rate, it could announce that it would lend reserves via repurchase agreements at the federal funds target level plus X basis points or it would borrow reserves via reverse repurchase agreements at the federal funds rate minus X basis points.

The Federal Reserve owns $6.4 trillion of securities outright of which $4.5 trillion are US Treasury securities. So, the Federal Reserve owns about 14-1/2% of total marketable Treasury debt outstanding. If the Federal Reserve is concerned about the market “digesting” $6.4 trillion of debt all at once, it could phase down the amount of reserves on which it would pay reserves over time. But one way or another, there is no reason why the Federal Reserve should continue to pay interest on bank reserves.