Former NY Fed President Bill Dudley Talks Kevin Warsh

Summary

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Podcast Summary: Bloomberg Opinion Contributor Bill Dudley Talks 'Warsh’s Approach to Fed Policy Is Deeply Flawed'

Podcast: Bloomberg Talks
Episode Date: July 31, 2026
Guest: Bill Dudley, Former New York Fed President
Topic: Bill Dudley's critique of Kevin Warsh's approach to Federal Reserve policy and its effects on markets and credibility.

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Episode Overview

This episode features an insightful discussion with Bill Dudley, the former President of the New York Federal Reserve, who takes a critical stance on Kevin Warsh’s recent approach as Fed Chair. Dudley’s central argument is that Warsh’s policy communication is deeply flawed, particularly the strategy of outsourcing signals to financial markets and providing inadequate clarity about future monetary policy. The conversation covers the danger of reduced transparency, the limitations of shifting policy tools, and the potential impact on Fed credibility and financial volatility.

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Key Discussion Points & Insights

1. The Flawed Press Conference and Market Reaction

• Opaque Communication: Dudley points out that Warsh failed to explain the reasons behind policy decisions and dissent within the committee, leaving markets confused.
  • Quote (Bill Dudley, 01:05):
    "It's weird when you're not explaining why people are dissenting ... There really was virtually no information about how the Federal Reserve is thinking about monetary policy ... The silence of Warsh was really quite toughening and the financial markets basically said thumbs down."
• Loss of Credibility: The confusing message led to erratic market reactions—long-term yields rose, while short-term yields fell—signaling diminished trust in the Fed’s direction.

2. Forward Guidance vs. Reaction Function

• Misconception About Forward Guidance: Dudley clarifies he’s not advocating for constant forward guidance, but insists markets need a clear reaction function to price assets and manage expectations.
  • Quote (Bill Dudley, 02:02):
    "The only time you really need forward guidance is when you're at the zero lower bound ... But that doesn't mean you don't want to know what the Fed's monetary policy reaction function is. And I think that's the real problem. Warsh in his comments is conflating the two and they're very, very different."
• Market Uncertainty Increases: Without knowing how the Fed will react to new data, participants are left guessing, which increases volatility and reduces credibility.

3. Volatility as a Policy Tool?

• Inefficient and Risky Approach: Dudley doubts the idea that increased market volatility—caused by ambiguous Fed communication—can meaningfully help control inflation without raising rates.
  • Quote (Bill Dudley, 03:30):
    "It's a very inefficient way of tightening financial conditions. You're basically driving up risk premium in markets. That's a deadweight loss to the economy."
• Credibility Eroded: Market confusion implies worries about the Fed’s resolve, resulting in less-anchored inflation expectations and complicating policy goals.

4. Internal Dissent and Chair Authority

• Chair’s Credibility at Stake: Dudley dismisses the likelihood of a serious mutiny against Warsh within the FOMC; such an event would mean the Chair has lost control, an untenable position for any leader.
  • Quote (Bill Dudley, 04:18):
    "I can't imagine a situation where the chairman allows himself to be outvoted by the committee because ... it basically would be saying that the chairman has lost control of the committee. And that's just not a very good look for any head of any organization."

5. Inflation Target Ambiguity and Policy Tools

• Balance Sheet Not a Substitute for Rates: Warsh’s hints at using the balance sheet over short-term rates are met with skepticism by Dudley, who notes the scale of possible quantitative tightening is limited and insufficient to move the needle.
  • Quote (Bill Dudley, 04:55):
    "You’re probably going to be able to reduce it by about $1 trillion or so... And then the question is how much restraint is shrinking the balance sheet by $1 trillion going to be? It's actually going to be very, very small. So the idea that ... you pull on this balance sheet lever and that allows you to not have to tighten monetary policy, I think is very much exaggerated."

6. Path to Regaining Credibility

• Actions Must Follow Words: To restore trust, Dudley argues the Fed now likely needs to tighten in September, given the damage done to credibility.
  • Quote (Bill Dudley, 05:52):
    "When you do a job really badly, sometimes you have to do more than you otherwise would have had to do... you almost need to tighten now because you have lost credibility over the last couple of months."
• Against Shock Moves: He warns a drastic rate hike would look like desperation rather than resolve.
  • Quote (Bill Dudley, 06:14):
    "If the Fed Reserve did 50 basis points move, that would be in my mind a little bit of a sign of desperation."

7. Roots of Warsh’s Approach: Political or Philosophical?

• Not Political, But Mistaken: Dudley rejects the idea that Warsh is acting out of political expediency, instead attributing his approach to a genuine—if misguided—belief in market-determined policy.
  • Quote (Bill Dudley, 07:00):
    "I can't judge that, but I generally think no, he's not trying to do it to sort of mollify the President. I think he really does believe that somehow outsourcing this to financial markets will improve the conduct of monetary policy. But you can't outsource it to financial markets for a very simple reason. Markets don't price to what the Fed should do, they price to what they think the Fed will do."

8. Circular Logic in Outsourcing to Markets

• Policy Paralysis Danger: Dudley points out the risk of recursive uncertainty when the Fed looks to markets for signals and markets look to the Fed, making the policy path indeterminate.
  • Quote (Bill Dudley, 07:00):
    "All you have is the markets looking at the Fed, the Fed looking at markets, and the interest rate path is indeterminate."

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Notable Quotes & Memorable Moments

• On Market Reaction:
  • “The financial markets basically said thumbs down.” (Dudley, 01:05)
• On Forward Guidance vs. Reaction Function:
  • “Warsh in his comments is conflating the two and they're very, very different.” (Dudley, 02:02)
• On Using Volatility as a Tool:
  • “It's a deadweight loss to the economy.” (Dudley, 03:30)
• On the Limits of Balance Sheet Reduction:
  • “The idea that ... you pull on this balance sheet lever and that allows you to not have to tighten monetary policy ... is very much exaggerated.” (Dudley, 04:55)
• On Outsourcing Policy to Markets:
  • “Markets don’t price to what the Fed should do, they price to what they think the Fed will do.” (Dudley, 07:00)
  • “Markets looking at the Fed, the Fed looking at markets ... the interest rate path is indeterminate.” (Dudley, 07:00)

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Timestamps for Key Segments

• [01:05] Bill Dudley on the breakdown in Fed communication and immediate market reaction
• [02:02] Delineating forward guidance from the need for a reaction function
• [03:30] Critique of using market-driven volatility as a substitute for monetary policy tightening
• [04:18] Discussion on FOMC internal dissent and Chair authority
• [04:55] Examining balance sheet reduction vs. policy rate moves
• [05:52] What it will take for the Fed to regain lost credibility
• [06:14] Risks of over-reacting with unexpectedly large rate hikes
• [07:00] Debate on Warsh’s motivations and the flaw in outsourcing policy to markets

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Summary

This episode provides a sharp critique of Kevin Warsh’s policy style, highlighting risks from lack of clarity, over-promising, and over-reliance on market reactions. Dudley appeals for clearer communication of policy intentions and warns that credibility, once lost, demands stronger action to recover. The conversation is packed with candid assessments, practical warnings about policy tools, and an insider’s view on the importance of leadership and institutional trust at the Federal Reserve.

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Transcript

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[Interviewer]

former New York Fed President Bill Dudley with a new op ed titled Watch. His approach to Fed policy is deeply flawed. He writes, outsourcing monetary policy to financial markets is a terrible idea. Walsh missed an opportunity to rebuild the Fed's credibility. Bill joins us now for more. Bill, welcome to the program. We were all watching that news conference and and it didn't start terribly and then progressively it just got more and more confusing. What was the point in that news conference where you sat up and said this is weird?

[Bill Dudley]

Well, it's weird when you're not explaining why people are dissenting. Yet the committee is deciding on no change in policy. There really was virtually no information about how the Federal Reserve is thinking about monetary policy, how the Federal Reserve is likely to react to incoming information in terms of how they adjust monetary policy. The silence of war was really quite toughening and the financial markets basically said thumbs down. I mean the fact that the 30 year yield went up, the 10 year wheel went up and 2 year yields dropped really was a sign that there was a loss of credibility in that from that press conference.

[Interviewer]

Bill, I want to highlight a distinction because I think it's important and it's in the body of your op ed and I want to say it for you, you're not against reducing forward guidance. This is important. I think that the complaints about the people doing the complaining are often are around the idea that somehow we still want our hands being held, that we want to hold on to the post GFC communication architecture. And Bill, I don't think that's what your criticism is about.

[Bill Dudley]

No, I mean I wrote a group of 30 paper that we published in April and one of the recommendations was to get rid of for guidance. The only time you really need for guidance is when you're at the zero lower bound for interest rates. You're trying to provide additional monetary policy stimulus but the rest of the time it really just sort of inhibits the Fed and probably makes the Fed a little bit slower to react to incoming Information. But what, but that doesn't mean you don't want to know what the Fed's monetary policy reaction function is. And I think that's the real problem. Washington in his comments is conflating the two and they're very, very different. If I don't understand how the Federal Reserve is going to react to incoming information, I can't price financial markets correctly. And it's also creating a lot of uncertainty about what policy is going to be in the future. You know, the market response on Wednesday was really Fed credibility has lessened. And I think this is really own goal on Kevin Warsh's part. You know, I think one of the problems I think is these overpromised and under delivered. You know, he's talked about, you know, sea change at the Fed, radical regime change, but then the markets are actually getting very, very little in terms of guidance on how to think about the new Fed bill.

[Interviewer 2]

We were discussing about whether maybe some of this was by design. There is going to be more volatility. There has been more volatility both at the front end and the long end in response to every economic data point and comment coming from anyone on the Federal Reserve as a result of an absence of some sort of reaction function articulated by the FOMC chair. Do you think this could be by design to help reduce inflation without hiking rates?

[Bill Dudley]

I don't think this is a really great strategy for a couple of reasons. Number one, it's a very inefficient way of tightening financial conditions. You're basically, you're driving up risk premium in markets. That's a deadweight loss to the economy. Number two, how well can you actually control the market process to generate the impulse that you want to slow the economy down sufficiently? And lastly, you know, it's a credibility issue. I mean if to the extent that the markets reacted the way they did on Wednesday, that's telling you that people are more worried about the Fed resolve to do the job. That means inflation expectations are less well anchored than they were prior to the press conference. That in itself makes the Fed's job harder.

[Podcast Announcer]

Bill, how high is the bar for

[Interviewer 2]

there to be, I don't want to say mutiny, but the bulk of the FOMC committee voting against the chair, potentially with the governors joining suit, I don't

[Bill Dudley]

think we would get to that. I think at that point Bush would throw in the towel and vote with the majority. I can't imagine a situation where the chairman allows himself to be outvoted by the committee because if you, if you had that result, it basically would be saying that the chairman has lost control of the committee. And that's just not a very good look for, for any, any head of any organization.

[Interviewer]

But he was also vague about the inflation target. That was confusing. Too vague on the inflation target, whether they'd respond to it and what tool they would use to respond. Can I pick up on that last point, Bill? He's flirting with the idea of using balance sheet instead of short term policy rates. Short rates, I think. What do you think of.

[Bill Dudley]

Well, I think the problem here is that even if you reduce the balance sheet, you're probably going to be able to reduce it by about $1 trillion or so if to continue to have an ample reserves regime. And I think the commitment of the committee is to maintain the ample reserve regime. And then the question is how much restraint is shrinking the balance sheet by $1 trillion going to be? It's actually going to be very, very small. So the idea that, you know, you pull on this balance sheet lever and that allows you to not have to tighten monetary policy, I think is very much exaggerated.

[Interviewer]

It's obvious that for the market, the primary tool is still the policy rate because you can see that the reaction this morning to the sensitive economic data that we got moments ago on wages, they came in hotter labor costs. You saw yields rise at the front end of the curve. But we've talked about this all morning, the credibility here. You say credibility has been hit. Others agree with you. Let's talk about how you repair it. When you do a job really badly, sometimes you have to do more than you otherwise would have had to do. How much more do they need to do now at this Federal Reserve to regain that credibility?

[Bill Dudley]

Well, I think you have to follow up, talk with action. So I think that what's happened in financial markets over the last 72 hours or so basically increases the pressure on the Fed to act in some September. If, if it's a jump ball in September, you almost need to tighten now because you have lost credibility over the last couple of months.

[Interviewer 2]

Do you think that it increases the chance of a larger than expected rate hike?

[Bill Dudley]

It's possible, but I don't think that you're so far away from your inflation objective that, you know, you need sort of shock therapy. If the Fed Reserve did 50 basis points move, that would be in my mind a little bit of a sign of desperation. Why didn't you, why didn't you hike in July and then you do 50 basis this point since September? I think that's actually is a confusing narrative as well.

[Interviewer 2]

What do you think the overall motivation is here? I mean we've been talking about this and a lot of people said Kevin Warsh is a 100% respected person by the mainstream of the financial markets, by the establishment. Do you think this is just rookies error, the classic kind of first press conference of a Fed chair, or do you think that there is some political motivation here trying to dodge the ire of the President going into the midterm elections?

[Bill Dudley]

I can't judge that, but I generally think no, he's not trying to do it to sort of mollify the President. I think he really does believe that somehow outsourcing this to financial markets will improve the conduct of monetary policy. But you can't outsource it to financial markets for a very simple reason. Markets don't price to what the Fed should do, they price to what they think the Fed will do. And so if you try to outsource it to markets, all you have is the markets looking at the Fed, the Fed looking at markets, and the interest rate path is indeterminate.

[Interviewer]

It's the spine that we were talking about yesterday. Yeah, we just everyone's pointing to each

[Interviewer 2]

other and I saw a couple versions of that Fed.

[Interviewer]

I'm sure you did, but it's good to see you. Thank you buddy. Phil Dante that the former New York Fed President thank you very much sir. Appreciate your time.

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