Warsh's Fed Inflation Plan Faces Wall Street Skepticism

Kevin Warsh, President Donald Trump’s pick for Federal Reserve chair, told the Senate he wants to change how the Fed measures inflation by using “trimmed averages” instead of the core PCE index, but economists warn the shift could create the opposite problem it aims to solve. At his Senate hearing on Tuesday, Warsh expressed skepticism of one-off price shocks and said he prefers a method that “cuts out all of the tail-risks, all of the one-off items,” to identify underlying inflation trends. However, Aditya Bhave, an economist at Bank of America, cautioned on Wednesday that this broader regime change at the Fed might backfire, potentially pulling food and energy back into policy calculations in ways Warsh did not anticipate.

Warsh’s Trimmed Average Proposal

At his Senate hearing, Warsh stated: “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?” He advocated for using trimmed averages, which remove the most extreme price readings from inflation calculations.

Under this method, inflation would appear softer than current measures. According to Bhave’s analysis, a 12-month gauge using the trimmed approach would have shown a mean of 2.3% and a median of 2.8% as of February, compared to the core PCE reading of 3%. At the hearing, Warsh called the inflation trend “quite favorable.”

The Ironic Problem: Smaller Shocks Remain

Bhave warned that Warsh’s proposed methodology contains a fundamental flaw. If the trimmed method removes only the biggest price readings, smaller price jumps can still remain in the basket—including potential increases from food and energy categories currently excluded from core PCE calculations.

Bhave explained the paradox: “Even if these shocks get trimmed out, they might still raise the trimmed mean by preventing other shocks from getting trimmed. This is ironic because Warsh also argued yesterday for looking through one-off, supply-driven price increases.”

Historical Precedent: 2019-2020

Bank of America’s data shows this problem has occurred before. The bank’s trimmed-median inflation gauge was above the core PCE in 2019 and 2020. In those years, using a trimmed basket would have pushed the Fed toward a more hawkish (rate-raising) stance than the core PCE suggested.

Fed Credibility and Rate Decision Implications

If trimmed inflation rises above the core PCE again, Warsh would likely face pressure to stick with his chosen metric to preserve Fed credibility. Bhave stated: “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.”

This matters because Fed rate decisions have immediate real-world effects. When the Fed raises rates, borrowing becomes more expensive for consumers and businesses, which can cool the economy and ease inflation. When the Fed cuts rates, spending can increase, but prices may also rise faster. Both high rates and high prices hurt consumers, forcing the Fed to balance competing pressures.

Senate Questions on Fed Independence

During the hearing, Senator Elizabeth Warren and other lawmakers questioned whether Warsh could resist pressure from Trump to lower rates. Warsh responded by emphasizing the central bank’s need for independence, stating in his prepared remarks: “Monetary policy independence is essential. Monetary policymakers must act in the nation’s interest, their decisions the product of analytic rigor, meaningful deliberation, and unclouded decision-making.”