Kevin Warsh gave his preferred way for measuring inflation. It could come back to bite him

Kevin Warsh, President Donald Trump’s nominee to head the Fed, told lawmakers he wants the central bank to change its strategy for measuring inflation.

But Bank of America economist Aditya Bhave warned Wednesday that such a restructuring, part of a broader “regime change” that Warsh has promised for the central bank, may not work out as he hoped.

The Fed has long favored a core price index for personal consumption expenditures, known simply as core PCE, because it excludes volatile food and energy prices.

But Warsh wants to go one step further by eliminating extreme price shocks when calculating overall inflation.

“What I’m most interested in is: What is the headline inflation rate? Not: What is a one-time change in prices because of a geopolitical change or a change in beef,” Warsh said during his Senate hearing Tuesday. he said.

“My preferred measures are to look at what are called truncated averages,” Warsh added. “We take out all the tail risks, all the one-off items, and ask ourselves whether the overall change in prices has second-order effects on the economy.”

Bank of America’s Bhave said inflation looks softer today under Warsh’s system. The bank found that its 12-month inflation gauge, using the trimmed method, would average 2.3% and average 2.8% as of February. By comparison, core PCE was at 3%.

Warsh called the current trend in inflation “pretty positive” at Tuesday’s hearing.

But that shift could mean energy and food, which are currently excluded, will become more important to Fed policy, Bhave said.

“Even if these shocks are clipped, they can still raise the clipped average by preventing other shocks from clipping,” Bhave said. “It’s ironic because Warsh also argued yesterday that we should look at one-off, supply-driven price increases.”

In other words, by trimming only the most extreme readings, perhaps some small increases in inflation caused by the jump in food and energy prices could be reflected in the inflation reading under Warsh’s method, causing inflation to be higher than the Fed’s current preferred view.

And data from Bank of America showed that this has happened in the past.

The trimmed median inflation gauge tracked by Bank of America was higher than the core PCE in 2019 and 2020. In those years, using a trimmed basket could have encouraged a hawkish stance from the Fed.

If subdued inflation outpaces the core PCE in the future, Bhave said Warsh would likely have to hold his own hands by standing by his view.

“To maintain the Fed’s credibility and avoid hasty approaches, Warsh will need to stick to his preferred benchmarks, even if they leave the core behind,” Bhave said.

Critics of Warsh said they expected him to steer the Fed in a direction that would please Trump rather than what was best for the economy.

At Tuesday’s hearing, Warsh abandoned the idea that he would cut interest rates only at Trump’s request. But the former Fed chairman has faced tough questioning about his wealth and ability to break with Trump.