Kevin Warsh is a man of catchphrases: task force, first principles, a good family fight. Catchphrases can be useful if we all attach the same meaning to them. Two days of hearings before Congress this week clarified that when Warsh commits to “price stability,” he attaches a different meaning to it than the rest of the Fed does. When I read “the Committee will deliver price stability” in the June FOMC statement, I translated that as PCE inflation at 2% by 2028. When I hear Warsh say "price stability," I am now unsure what he means.
If we do not all agree on the yardstick, then a commitment to price stability is nearly meaningless. The yardstick also helps everyone see whether monetary policy is working or whether the Fed needs to change course. The Fed worries about unanchored inflation expectations; I am starting to worry about a Fed Chair who is unanchored from inflation data.
Why can I translate the FOMC statement, but I can’t translate Warsh? In 2012, the Fed adopted an explicit inflation target—it specified a level (2%) and a yardstick (the PCE price index). When anyone at the Fed says price stability, that's what they mean, and after fourteen Januaries of the FOMC reaffirming that definition, it's how everyone outside the Fed understands it, too:
FOMC: The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee can specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory maximum employment and price stability mandates.
At his first press conference, Warsh confirmed that 2% is the target level, but he did not, and has not, confirmed that PCE prices are the yardstick. In fact, aside from reading out results from the FOMC projections that he chose not to participate in, Warsh has not referred to PCE prices once during his confirmation hearing, first press conference, a central banker panel in Sintra, or two days of congressional testimony. PCE inflation is the yardstick at the Fed. That’s a glaring omission for a Fed Chair, and for a person who likes catchphrases, it’s unlikely to be an oversight.
Warsh’s departure from the Fed’s yardstick goes deeper than a missing data source. In his written testimony this week, Warsh shifted what monetary policy is claimed to determine (compare the blue highlights):
Warsh: While monthly price fluctuations are inevitable—especially in an unsettled world—underlying inflation over longer time horizons is determined largely by monetary policy. The members of our Committee have no tolerance for persistently elevated inflation. And we share a resolute commitment to restoring price stability.
The green highlights in the FOMC quote above are missing from Warsh’s altogether. The FOMC framework discusses the inflation rate, as reported by the Bureau of Economic Analysis, whereas Warsh discusses underlying inflation, a concept for which there is no official estimate. Inflation and underlying inflation are not interchangeable terms.
What is inflation, and what is underlying inflation?
A lesson of the affordability debate in recent years is that much time can be lost arguing past each other if we don’t agree on terms. It’s valid to talk about the overall level of prices, price changes over the past year, and the trend in price changes, but it’s confusing to throw them all into one word: inflation. The stakes are real—there could be a lot of frustration in a few years if we all just ‘misunderstood’ Warsh, and we could end up with some bad monetary policy if he is confused about the goal.
Inflation is the measured change in the prices people actually pay. Underlying inflation is an estimate of where inflation is heading once temporary factors wash out. Core, trimmed mean, and median are all measures of underlying inflation. For the Fed, inflation at 2% is a goal; underlying inflation helps calibrate policy to reach it.
The Fed’s website explains the distinction, first with inflation:
Inflation is the increase in the prices of goods and services over time. Inflation cannot be measured by an increase in the cost of one product or service, or even several products or services. Rather, inflation is a general increase in the overall price level of the goods and services in the economy … The FOMC uses the PCE price index [for its inflation target] largely because it covers a wide range of household spending. [Emphasis added throughout.]
The breadth and representativeness are critical. Price stability is about all prices. That’s why the target is headline inflation, measured by the Personal Consumption Expenditures price index.
A focus on underlying inflation, in contrast, is a means to the end of price stability:
Policymakers examine a variety of "core" inflation measures to help identify inflation trends. The most common type of core inflation measures exclude items that tend to go up and down in price dramatically or often, like food and energy items … Although food and energy make up an important part of the budget for most households—and policymakers ultimately seek to stabilize overall consumer prices—core inflation measures that leave out items with volatile prices can be useful in assessing inflation trends.
When determining the right level of the federal funds rate, Fed officials consider where inflation is likely headed after temporary factors fade. For example, if underlying inflation is above 2%, the Fed might raise rates to bring future inflation to 2%, but if the trend is close to 2%, raising rates would create unnecessary economic weakness. In that case, it might be better to hold rates steady, even if current inflation is elevated.
Price stability is 2% PCE inflation. That’s the goal. PCE inflation is the yardstick for measuring the Fed’s success. Underlying inflation, regardless of its form or source, is a sideshow to that goal — an important one, but a sideshow.
Confused. Is there a task force for that?
Warsh's testimony before Congress this week included several exchanges that could cause some confusion. I'm not claiming Warsh is confused, but he uses standard terms in nonstandard ways. Three examples.
Confusion about what the statistical agencies like the BLS and BEA do.
In promoting his data task force to Senator Scott, Warsh claimed that the CPI and PPI are not good measures of underlying inflation:
Warsh (19:04): In the last couple of days, we've gotten data on the consumer price index — today on the producer price index. Any central bank would be happy to have the data going in the right direction. My view is these are all imperfect measures of the state of underlying inflation. So one of the task forces is going to see whether we can do better—have better data from external sources, and even better ideas as to how important organizations like the Bureau of Labor Statistics, the Bureau of Economic Affairs [sic: it’s the Bureau of Economic Analysis] might think about how they could do a better job in an evolving economy.
Why would they be? The BLS and the BEA do not publish underlying inflation. They publish actual inflation — price changes across a wide range of goods and services — in the CPI, PPI, and PCE. Others can construct measures of underlying trend inflation from these sources or alternative data sets, but the statistical agencies are not in that business. Of course, inflation measurement can be improved, though no one on Warsh’s data task force has experience in that work.
What the BEA does, with input from the BLS, is publish the Fed’s yardstick, PCE inflation. The way Warsh talks about the data task force telling the agencies how to improve runs the risk of asking the referee to shorten the yardstick.
Confusion about what would make a good measure of underlying inflation.
It made news at Warsh’s Senate confirmation hearing when he said he preferred trimmed averages, but he clarified to Representative Torres this week that he’s not satisfied with existing versions:
Warsh (2:47:41): So, none of those [like the Dallas trimmed mean] are very good measures of underlying inflation. That Wall Street Journal story that you referenced is incorrect — that I have a preferred measure from one of the reserve banks. If I had a preferred measure, I wouldn’t have called for a task force to go back to first principles, and the data task force will be looking importantly at inflation measures. My view is that we need new measures to understand the underlying changes in inflation. Am I interested in what’s the mean or median price of a good at a big box retailer? You bet I am. And none of these measures capture that. I am super interested in finding new measures to do a better job to help us inform our decisions so that the inflation of the last five years doesn’t continue.
Why would the pricing dynamics of goods at one type of retailer be a good indicator of where PCE inflation—the Fed’s yardstick—is headed after temporary factors fade? Services like health care, housing, travel, and restaurants make up the bulk of spending in the economy, but very little of Walmart’s sales. Also, PCE already includes big-box retailers. A narrower measure of inflation can sometimes help read the trend in overall inflation, but a narrow and unrepresentative one is unlikely to perform well. Again, the Fed’s goal is 2% PCE inflation.
Confusion about what inflation is.
These two exchanges with Senators Kennedy and Reed drove it home to me. When Warsh says “inflation,” he does not mean inflation, as in the “change in overall prices.”
Kennedy (1:02:56): Now, well, now we have inflation. Okay. What caused it? In 20 seconds.
Warsh: In 20 seconds—inflation is caused when a one-time change in prices broadens out—
Kennedy: I know what inflation is. Tell me what caused it.
Warsh: Monetary policy, sir.
Kennedy: Okay. Well, I would say what is causing it is AI. The conflict with Iran. Duh. And probably the residual effect of the fact that some imports have become more expensive. Okay? And I think any fair-minded person would conclude that. There was a lot of economists said, oh, the impact of inflation on the rise of the cost of imports would be a one-shot deal …. I don't know. I think it's probably a residual effect. Okay. Is it temporary? Is it permanent? The inflation?
Warsh: It's not going to be permanent under my watch, Senator.
No one could plausibly attribute the 4.1% PCE inflation in May—the most recent reading—solely to monetary policy. I argued in an earlier post that the underlying trend inflation was likely 2.5% to 3%. Assigning the excess of that trend over the 2% target. which is a half a point or so, to monetary policy could be reasonable, but that’s not what Senator Kennedy asked. Kennedy’s own answer with AI, Iran, and imports shows how everyone else hears the word inflation.
The answer to Senator Reed’s question was equally confusing:
Reed (37:00): Recently, Governor Waller and New York Fed President John Williams have warned that AI investments may be increasing inflation, and many economists have similar warnings. So are AI investments current drivers of inflation?
Warsh: This is one of the good family fights. Let me give my own view on it, which might be somewhat nuanced from the way you just described it and some of my colleagues. The supply shock of AI has an effect on demand and supply. We see the effect on demand much more quickly. We see it in the capital investment I referenced. We see it in the prices of chips that are going up. We’re inferring—which is just a fancy word for guessing—when the effects will happen on the supply side of the economy. I don’t view a one-time change in prices as necessarily being inflationary, because I think there’s a supply response. In that way, this is different from a foreign conflict and what it might do, which tends to reduce the supply side of the economy. Will it increase measured prices over the course of the next 12 months? I suspect it will. Whether that’s inflationary or not, that’s up to the Federal Reserve, and we’re going to have something to say about that.
It's not a family fight over whether AI is pushing up inflation. It is clearly in the data. The question is whether that will be temporary. Warsh is tying himself in knots to avoid sounding like Powell's transitory explanations of pandemic or tariff inflation. It also raises the question of whether Warsh accepts that the yardstick is actual inflation.
In closing
Kevin Warsh came to the Fed promising regime change, better communications, and a credible commitment to price stability. Fair enough. Then say the sentence: "The goal is 2% inflation, as measured by the annual change in the PCE price index." Every chair since 2012 has said it, one way or another, over and over. Warsh has committed to the 2% while never once naming the yardstick it's measured with. A commitment that gets lost in translation is not good communication. A chair of catchphrases should understand better than anyone: the words only work if we all attach the same meaning to them.
I keep going back and forth on how worried I should be about the data task force. It was five alarm fire, then three alarm fire, and I think I’m back to five alarm fire. Great write up on the nuances of inflation!
Thanks for this analysis. You made it apparent that the average citizen (me) and maybe astute Congress people need a well qualified interpreter to understand FedSpeak. A likely collary is that the data task force will figure out how to muddle data even more.