Warsh's Preferred Inflation Metric May Backfire, Bank of America Warns

Federal Reserve Chair nominee Kevin Warsh outlined his preferred approach to measuring inflation during Senate testimony, but economists caution the strategy could create unintended complications for monetary policy.

Warsh, Trump's pick to lead the central bank, indicated during Tuesday's Senate hearing that he would pursue a shift in how the Fed calculates inflation. Rather than continuing reliance on the core personal consumption expenditures index—which strips out volatile food and energy costs—Warsh advocates for trimmed average measures that eliminate extreme price fluctuations entirely.

The Case for Trimmed Averages

"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 stated at the hearing.

He elaborated on his reasoning: "The measures I prefer are looking at things that are called trimmed averages. 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."

Under this methodology, inflation appears considerably softer. Bank of America's analysis found that a 12-month trimmed inflation gauge would register a mean of 2.3% and median of 2.8% as of February—notably below the current core PCE reading of 3%. Warsh characterized this current inflation trajectory as "quite favorable" during the hearing.

Potential Pitfalls of the Approach

However, Aditya Bhave, an economist at Bank of America, raised significant concerns about the practical implications of switching to trimmed averages. He warned Wednesday that the reconfiguration—part of a broader "regime change" Warsh has promised for the Fed—could produce counterintuitive results.

According to Bhave's analysis, the trimmed method might paradoxically increase the weight of food and energy shocks in Fed decision-making, contrary to Warsh's stated intentions. "Even if these shocks get trimmed out, they might still raise the trimmed mean by preventing other shocks from getting trimmed," Bhave explained. "This is ironic because Warsh also argued yesterday for looking through one-off, supply-driven price increases."

The concern boils down to this: by removing only the most extreme price readings, more moderate inflation spikes—potentially driven by food and energy costs—could remain visible in the trimmed metric and push it higher than the Fed's current core PCE measure.

Historical Precedent

Bank of America's historical data demonstrates this risk is not theoretical. The bank's trimmed-median inflation gauge exceeded core PCE readings in 2019 and 2020. Had policymakers been using trimmed metrics during those periods, they would have faced pressure to adopt a more hawkish stance on interest rates.

This historical pattern presents a credibility challenge for Warsh. "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 cautioned. In essence, Warsh would be bound by his own methodology even if it produced less favorable inflation readings than current measures.

Broader Concerns About Independence

The debate over inflation metrics reflects wider concerns among Warsh's critics, who argue he may prioritize policies favoring Trump over those serving the broader economy. During Tuesday's hearing, Warsh dismissed suggestions that he would cut interest rates simply at the president's behest. Nevertheless, lawmakers pressed him on his considerable wealth and his capacity to maintain independence from Trump, highlighting tensions that may persist if he takes the helm of the central bank.