Warsh’s Fed Is Losing Control of the Nominal Economy

Julius Probst, PhD examines why nominal spending is running far too hot, and what the Fed's loss of control means for wages and hiring.

Photo credit: Emilio Takas

Earlier this year, President Donald Trump nominated Kevin Warsh to be the new chairman of the Federal Reserve (Fed), America’s central bank, which is responsible for price stability and setting interest rates. Monetary policy has an outsized influence on inflation, wages, and employment trends. In fact, there are few things that matter more. Price pressures have remained elevated since the pandemic, and inflation has been accelerating again through 2026. The AI investment boom is driving up input prices and pay in the industries most exposed to it. With financial markets questioning Fed competence at a crucial time, there is a risk that monetary policymakers are losing control of the nominal economy. This should concern workers and employers alike.

Warsh’s latest press conference confused markets

Warsh was an odd choice. Trump is a self-proclaimed low-interest guy, while the new chairman has historically been known as an inflation hawk — in the aftermath of the global financial crisis, he was more concerned about inflation than persistently high unemployment. But since his appointment, Warsh’s attitude might have shifted. It’s hard to know for sure, since his signals have been anything but clear. Financial markets were left confused after the last press conference two weeks ago when the Fed left rates unchanged. Warsh doesn’t believe in forward guidance — offering a guess about the future path of interest rates to steer markets. Removing that from the central bank’s toolkit is all well and good, but it doesn’t work if the chair is not 100% explicit about the Fed’s reaction function — the rules of how monetary policy will respond to economic outcomes. And he wasn’t. This left investors guessing and resulted in a substantial spike in long-term interest rates: 10-year government bond yields rose by seven basis points on the day of the press conference. In case you didn’t know, this is a big deal! The U.S. bond market is one of the largest and most liquid financial markets in the world. Such a surge in interest rates is not just a harbinger of macroeconomic volatility; it also shows that investors are expecting inflation to increase.

Inflation is rising again

You might now object that the acceleration is a result of the oil price shock, and there is some truth to that, as we pointed out earlier this year. But core inflation — a measure stripping out volatile food and energy prices — is accelerating too: the core Personal Consumption Expenditures (PCE) rate is exceeding 3%, while the Fed is supposedly targeting an increase of 2%.

The US is experiencing a surge in nominal spending

There is a straightforward explanation for why underlying inflation is rising, and it has nothing to do with energy shocks: The U.S. economy is experiencing a nominal spending boom. As a reminder, real GDP growth basically means producing more output with the same resources (it’s an efficiency gain), while nominal GDP growth is the change in the total dollar value of all goods and services in the economy (nominal growth is the sum of real GDP growth and inflation). A spending surge might simply drive up prices and wages across the board without leaving anyone better off.

This is exactly what’s happening right now. Following the post-pandemic economic boom, nominal GDP growth finally slowed to a healthier 5% by mid-2025. However, in the second half of last year, it reaccelerated, surpassing 6% in the first quarter of 2026. Even more shocking, the latest data shows it growing by 7.9% in the second quarter, a level that is roughly 3 percentage points too high to be consistent with the Fed’s inflation target of 2%. For the third quarter, the Fed’s GDP Nowcast currently anticipates 5.8% real growth, which would be consistent with more than 8.5% nominal growth. This miss represents a spectacular failure in monetary policymaking, with the Fed severely underestimating the strength of the current inflationary boom. How come, you ask?

The AI investment boom is inflationary

Economists are currently debating whether AI is inflationary. If the technology produces large productivity gains, this could very well reduce inflation. An investment and consumption boom, on the other hand, would be inflationary, at least in the short run.

While Warsh has positioned himself on the side of AI lowering inflation, the data suggests the opposite is the case. Large U.S. tech companies are on track to spend $1 trillion this year on capital expenditures. The data center construction boom is about to surpass previous technological cycles, such as the dot-com era, in terms of investment committed. And the infrastructure spending is starting to push up input prices and wages, driving up construction costs. Meanwhile, stocks are surging and American consumers are spending their money faster than ever. This wealth-driven consumption boom is another factor pushing up inflation.

Is the Fed correcting course?

While several Fed governors recently indicated that they are uncomfortable with current policy and would consider hiking interest rates soon, the weak employment numbers might have thrown a wrench into that plan. Prediction markets show that the probability of a September rate hike fell from 60% in early August to 40% after the jobs report, and to 34% following today's CPI release, even though inflation remains well above the Fed's 2% target.

Why more demand won’t create many jobs

A significant nominal spending boom such as the one the U.S. is currently experiencing would, under normal circumstances, be quite bullish for job creation. But here is the problem. By most measures, the U.S. labor market is already close to full employment. The unemployment rate is low and labor force participation high. The aging workforce and Trump’s immigration policies have reduced breakeven job growth — the level of job creation consistent with stable unemployment — to about 50,000 jobs per month. This means that all the additional spending from the AI boom is facing severe supply constraints. Instead of boosting employment, it’s simply pushing up prices and wages.

What does this mean for recruiters?

The Fed has allowed the nominal economy to grow at a much faster pace than warranted. The end result will not just be higher inflation, but also higher wages. With job creation constrained by demographics and migration policies, workers will do their best not to let higher prices erode their purchasing power. And the AI boom is giving them plenty of ammunition. We are seeing a surge in demand for workers with AI skills. Many healthcare occupations also remain extremely hard to fill. And above all, hiring for any job related to data center construction is booming. Following two years of moderate wage pressure, recruiters should anticipate compensation demands creeping up in these segments, with potential knock-on effects for the rest of the labor market. While good for workers, this will become a problem for squeezed employers who can’t afford more wage competition.