President Donald Trump’s nominee to be Fed Chair said he would like a new strategy in how the central bank measures inflation.
Kevin Warsh told lawmakers this week at a Senate Banking Committee confirmation hearing that he wants to root out extreme price shocks when calculating inflation by using a trimmed inflation gauge. The Fed, however, has favored the core price index for personal consumption expenditures, known in short as the core PCE, because it excludes volatile food and energy prices.
Bank of America Cconomist Aditya Bhave warned, however, that such a reconfiguration — part of a broader “regime change” that Warsh has promised for the central bank — might not work as he hopes.
“What I’m most interested in is: What’s the underlying inflation rate? Not: What’s the one-time change in prices because of a change in geopolitics or change in beef?” Warsh said at his Senate hearing Tuesday, CNBC reported.
“The measures I prefer are looking at things that are called trimmed averages,” Warsh said. “We take out all of the tail-risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy.”
Trimmed Method ‘Softened’ Inflation
Bhave said that under Warsh’s system, inflation today does look softer. He said the bank found a 12-month inflation gauge that’s using the trimmed method would have a mean of 2.3% and median of 2.8% as of February. By comparison, core PCE sat at 3%.
At his hearing, Warsh called the current trend in inflation “quite favorable.”
Bhave said, however, that making this switch might mean that energy and food — currently excluded — would matter more for Fed policy.
“Even if these shocks get trimmed out, they might still raise the trimmed mean by preventing other shocks from getting trimmed,” Bhave said. “This is ironic because Warsh also argued yesterday for looking through one-off, supply-driven price increases.”
In other words, CNBC said, by trimming only the most extreme readings, some more minor spikes in inflation — perhaps caused by food and energy prices jumping — could creep into the inflation reading under Warsh’s method and cause it to be higher than the Fed’s current preferred view.
Bank of America said its data shows that’s happened in the past.
A trimmed-median inflation gauge tracked by Bank of America was higher than the core PCE in 2019 and 2020. In those years, Bank of America noted, using a trimmed basket would have encouraged a hawkish stance from the Fed.
If trimmed inflation outpaced the core PCE in the future, Bhave said, Warsh likely would need to stand by his view, tying his hands.
Preferred Metrics
“To preserve Fed credibility and avoid optics of cherry picking, Warsh will need to stick with his preferred metrics even when they are outpacing the core,” Bhave said.
Warsh’s critics have said they expect him to sway the Fed in a direction that appeases Trump rather than by what’s best for the economy.
During Tuesday’s hearing, Warsh pushed back on the idea that he would lower interest rates solely at the president’s request. But Warsh, a former Fed governor, faced tough questioning over his wealth and ability to break with Trump, CNBC said.
