Kevin Warsh urges Fed to reconsider inflation metrics

Kevin Warsh urges Fed to reconsider inflation metrics

Federal Reserve Chairman Kevin Warsh has called for a shift in the way inflation is measured, suggesting that the central bank should consider alternative metrics.

The call comes as two different measures of "core" consumer inflation have given conflicting results.

The Commerce Department reported a core inflation rate of 3.3% over the past year, while a lesser-known measure called "trimmed mean" inflation stood at a more moderate 2.3%.

Shift from technical debate to policy question

At his confirmation hearing in April, Warsh urged the Fed to consider alternative measures like the trimmed mean.

This suggestion has transformed a technical debate among economists into a pressing policy question.

The key issue is whether these alternative measures are better at filtering out the impact of tariffs, AI investment, and geopolitical shocks on underlying inflation trends.

Warsh's focus on long-term trends

Warsh has made it clear that he is more interested in the underlying inflation rate than one-time price changes due to geopolitical events or specific commodities.

He said, "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 a change in beef."

This statement underscores his focus on long-term trends rather than short-term fluctuations.

Criticism of core prices

The Fed usually focuses on the Commerce Department's Personal Consumption Expenditures (PCE) price index to define its inflation target.

It captures a wider range of spending and adjusts for consumer behavior changes due to price shifts.

However, Warsh has criticized core prices as a "rough swag" or an inelegant approximation because they leave in too many other one-off distortions.

Predictive power of trimmed mean measure

The Dallas Fed's trimmed mean measure has been shown to better predict future price growth over long periods.

However, it failed in 2021 when inflation began rising sharply during the pandemic.

This failure is partly attributed to how the index was designed, which inadvertently understated the upward trend in inflation by discarding more of the increases than decreases.

Current state of trimmed mean measure

Currently, the trimmed mean is showing less inflation than broader indexes, raising questions about its accuracy.

In April, trimmed mean inflation was 0.7% points lower than core PCE, mainly because it weighted goods excluding food and energy (the most directly affected by tariffs) less.

A left-leaning think tank's measure of the PCE index symmetrically trimmed stood at 3% in April.