Kevin Warsh, President Donald Trump’s pick to lead the Federal Reserve, told lawmakers he wants the central bank to change its strategy for measuring inflation.
But Aditya Bhave, an economist at Bank of America, warned on Wednesday that such a reconfiguration, part of a broader “systemic change” that Warsh has promised the central bank, may not work out as he hoped.
The Fed has long favored a core price index of personal consumption expenditures, known as core PCE, because it excludes volatile food and energy prices.
But Warsh wants to go a step further by eliminating extreme price shocks when calculating overall inflation.
“What I’m most interested in is what is the underlying inflation rate? Not what are the temporary price changes due to changes in geopolitics or changes in beef,” Warsh said at a Senate hearing Tuesday.
“My preferred measure is to look at something called the trimmed mean,” Warsh added. “We remove any tail risks, all one-off risks, and ask ourselves whether the general change in prices is having a second-order effect on the economy.”
Bank of America’s Mr. Babe said that under Mr. Warsh’s system, inflation certainly looks softer today. The bank found that 12-month inflation using the trim method averaged 2.3% and median 2.8% as of February. In comparison, core PCE was only 3%.
Warsh said during Tuesday’s hearing that current inflation trends are “quite positive.”
be careful what you wish for
But Beebe said the switch could make energy and food, which are currently excluded, more important to Fed policy.
“Even if these shocks are reduced, the trimmed average could still rise because it prevents other shocks from being reduced,” Babe said. “This is ironic because Mr. Warsh also insisted yesterday that he would take into account one-off supply-driven price increases.”
In other words, by trimming only the most extreme measurements, a measure of inflation based on Mr. Warsh’s method could incorporate smaller spikes in inflation, perhaps caused by higher food and energy prices, making it higher than the Fed’s current recommended view.
And Bank of America data shows that this has happened in the past.
The adjusted median inflation rate tracked by Bank of America was higher than core PCE in 2019 and 2020. At that time, using an adjusted basket would have encouraged the Fed’s hawkish stance.
If adjusted inflation exceeds core PCE in the future, Warsh will likely have to tie his hands and stand by his views, Beebe said.
“In order to maintain the Fed’s credibility and avoid it from a cherry-picking standpoint, Warsh will need to stick to his preferred metrics, even if they are outperforming the core,” Babe said.
Mr. Warsh’s critics said they expect him to move the Fed in a direction that appeases President Trump rather than what’s best for the economy.
At Tuesday’s hearing, Warsh rejected the idea of lowering rates solely at President Trump’s request. But the former Fed director faced tough questions over his wealth and ability to break with President Trump.
