Warsh: "We're Sticking With It" ... Until January

This week, Warsh affirmed PCE inflation as the Fed's target, then put that yardstick on the chopping block.

A few weeks ago, I posed a question for Kevin Warsh: “2% of what?” Listening to his Congressional testimony, I became concerned that PCE inflation was not his yardstick for judging success at the Fed. I also wrote about him conflating target inflation and underlying inflation.

2% of What?

Yesterday, we got his answer. A half hour into the press conference, Paul Wiseman of the Associated Press asked the question:

WISEMAN: When you talk about the 2 percent inflation target, what measure are you relying on?

Today’s post is about Warsh’s answer, but let’s start with the correct answer: PCE inflation. That’s been the Fed’s official target measure of inflation since 2012. Warsh started out down that path, albeit a winding one:

WARSH: Yeah, so, I'll give two answers. First let me give the proper standard answer, the Federal Reserve every January outlines a statement of purposes and strategy, and in that strategy document, which I believe was dated January of this year, it describes a measure of PCE inflation as the -- as the objective function there. I have enough of my -- so that's our number, we're sticking with it.

His label of a “proper standard answer” comes across as grudging, but Warsh nailed the landing: “PCE … We’re sticking with it.” Unfortunately, Warsh did not stop there. The next part is where problems crept in:

Who knows come after next January what we might say about strategy. I suspect the task forces might have something to add.

That's the part that should worry you: Warsh is using PCE as the yardstick now, but he suggested he might pick a different inflation measure in January 2027. Choosing a new inflation measure that reads 2% is not achieving price stability; it's destroying the Fed's credibility.

The January vote is a routine reaffirmation of the Longer-Run Goals and Strategy statement, not a framework review. The Fed just completed its intensive, five-year review last year, and deliberately kept the target off the table. Since the first statement in 2012, the January vote has only ever affirmed the use of PCE inflation, never questioned it. And he pointed to his handpicked task forces as the ones who might drive that change.

And Warsh kept going:

But I'll say this, some version of the Lucas critique, some version of Goodhart's Law in economics, should remind us that when we talk about measures of inflation or something else, and we describe those measures as being consistent with our objectives, we might make them such that they're not very good measures or very good objectives.

The Lucas critique and Goodhart's law are irrelevant to a question about which inflation measure the Fed targets. The target isn't an economic relationship that shifts as people respond to policy. It's a measurement. There are real concerns you can raise about PCE as an inflation measure, but Lucas and Goodhart aren't among them.

Warsh wraps up his answer on the inflation target by talking about underlying inflation—a different concept altogether:

Broadly, if you said to me standing in front of you, I abide fully by the strategy document, we're going to deliver 2 percent inflation, and not a whisper more, but to achieve that, I'm looking at a broader set of inflation data than PCE. So, without sort of fully revealing my cards, I'm trying to understand like my colleagues, what's the underlying generalized change in prices that are happening in the economy. It is not a perfect science. I might have said 42 days ago, I've got a task force for that. But we have a data project that's trying to look and see whether we can't separate the noise from the signal. And so if you would hear a message from me, yes, I care about what the PCE prints are, I care about what the contributions are from CPI and everything else, but my -- my lens is broader than that. Even though the remit is quite narrow.

The Fed has one target (2% PCE inflation) and many ways to assess whether we are moving toward the target (measures of underlying inflation). It's fine, and standard, for Warsh to watch core, trimmed mean, median, and anything else that helps read the trend. Those tell him where inflation is heading. But the goal, the thing he's accountable for hitting, is PCE inflation.

One last part of his reply is worth flagging: Warsh’s “without sort of fully revealing my cards” approach was a running theme during the entire press conference. Warsh doesn’t say much, not about policy, not about data. On Marketplace, before the meeting, I said that it’s “unsettling” to have a Chair who doesn’t talk about the data. That concern remains.

In closing

Warsh’s answers are not an academic exercise. They are graded in the real world. The answer to this question on the target inflation measure and several others during his 45-minute press conference raised real concerns about Warsh’s commitment to fighting inflation.

The reaction in financial markets was swift and unmistakable. Stocks, bonds, and the dollar all fell during his remarks. The 30-year Treasury yield jumped to its highest since 2007, and markets pared the odds of a near-term hike. These moves came during the press conference, not on the decision to hold, and they were large for a Fed meeting.

This was only Warsh’s second meeting, so there’s time to course correct. Warsh keeps invoking first principles. Here's one: commit to PCE, stand by it, and deliver on it.