Kevin Warsh Sparks '3.3% vs 2.3%' Inflation Debate

Warsh, Fed Chair Nominee, Proposes a New Approach to Measuring Inflation
Emphasizes the 'Trimmed Mean' That Excludes Extreme Values
Warns That Inflationary Pressures Could Be Missed in the Short Term

The debate over which inflation indicators should serve as the basis for monetary policy decisions is intensifying, as Kevin Warsh, nominee for Chair of the U.S. Federal Reserve (Fed), argues that the Fed should pay closer attention to new price indices.

Kevin Wash, Fed Chair Nominee. Photo by AP Yonhap News

According to The Wall Street Journal (WSJ) on May 31 (local time), the core Personal Consumption Expenditures (PCE) price index rose 3.3% year-over-year in April. This figure is significantly higher than the Fed's 2% inflation target. In contrast, the "Trimmed Mean PCE" index calculated by the Federal Reserve Bank of Dallas increased by just 2.3%. This means that assessments of inflation diverged by as much as 1 percentage point, even when evaluating the same economy.

The controversy was ignited by remarks from Warsh. During his Senate confirmation hearing in April, Warsh stated, "The data currently used to assess inflation is quite incomplete," and argued that alternative indicators such as the 'Trimmed Mean' should be prioritized over traditional price indices.

A Time of Structural Change in the U.S. Economy... Warsh Highlights 'Trimmed Mean' That Excludes Extreme Price Fluctuations

So, what is the 'trimmed mean inflation' index referenced by Warsh? This method involves listing the price change rates of all items in order and then calculating the average after excluding the items with the largest increases and decreases.

The Dallas Fed developed a 'Trimmed Mean PCE' index specialized for the PCE by applying this approach. The rationale is that this index captures underlying inflation trends better than the core PCE, which only excludes food and energy. By removing extreme price fluctuations, the goal is to measure the overall trend of prices in the economy.

In 2009, after the Bureau of Economic Analysis (BEA) overhauled the PCE data system, the Dallas Fed also revised its trimmed mean calculation to the current method, which excludes the bottom 24% and top 31% of price changes in the distribution.

For example, in February of this year, phone and telecommunications equipment prices plummeted 50.8% on an annualized basis, while moving, warehousing, and freight service prices surged 384.6%. The Trimmed Mean PCE excluded such extreme price changes from its calculation.

The reason Warsh is emphasizing the Trimmed Mean PCE is due to increased volatility in specific item prices caused by recent tariffs, artificial intelligence (AI) investment, and geopolitical risks in the Middle East. This perspective interprets price increases resulting from tariffs or geopolitical shocks as temporary price shocks rather than persistent inflationary pressure.

Warsh's comments at last month's Senate hearing, in which he urged the Fed to pay more attention to indices like the trimmed mean, support this interpretation. He stated, "What I am most concerned about is fundamental inflation," adding, "It is not about one-off price changes due to geopolitical shifts or a sudden spike in beef prices."

Concerns About Underestimating Inflation... Should Not Be Used to Ignore Uncomfortable Prices

However, there is considerable criticism that the trimmed mean may actually understate inflation risk. During periods of broad-based inflationary pressure resulting from structural economic changes—such as the oil shocks in the 1970s or the COVID-19 pandemic in 2021—the trimmed mean has been shown to underestimate actual inflation.

In 2021, as inflation surged during the pandemic, the Fed and other policymakers considered rising prices a transitory phenomenon. The Dallas Fed's trimmed mean index also showed a relatively moderate inflation trend, but inflation subsequently soared to multi-decade highs, leading to criticism that the index underestimated inflationary pressure, as explained by the WSJ.

Recently, the Dallas Fed analyzed that the main reason the Trimmed Mean PCE has been consistently lower than the core PCE is that it excludes much of the price increases for goods affected by tariffs.

Brookings Institution CI

The Brookings Institution also noted that while trimmed mean and median inflation indices are useful for identifying long-term trends, they may miss actual inflationary pressures in the short term. In particular, Krishna Guha of Evercore pointed out that considering economy-wide factors—such as tariff or energy price shocks—as mere outliers "poses a systematic risk of underestimating the pace of inflation."

Ultimately, as the WSJ points out, the crux of the debate is not simply about inflation measurement techniques, but rather about the monetary policy philosophy of how seriously the Fed should regard rising prices in an era of frequent tariffs and geopolitical shocks.

Riccardo Trezzi, a former Fed economist, commented, "The key issue is whether the Fed will consistently use the principle of 'looking through' price shocks as a policy framework, or whether it will use it as a means to disregard inconvenient inflation indicators."

This content was produced with the assistance of AI translation services.