Inflation Monitor: Warsh Dismisses 'Rough Swag'

Is the Federal Reserve's preferred inflation gauge about to fall out of favor? It might, if it's up to Kevin Warsh.  

Warsh, who appears poised to become the new Fed chair, told the Senate Banking Committee during his confirmation hearing that the Fed's current preferred gauge, the core Personal Consumption Expenditures (PCE) index, offered only a "rough swag" on inflation, "swag" being short for "scientific wild guess."

Warsh has stated a preference for "trimmed" gauges—specifically, the Dallas Fed's trimmed mean PCE and the Cleveland Fed's median PCE. The most recent readings from March show their differences. While both PCE and core PCE rose to multi-year highs above 3%, the trimmed gauges barely budged and remain at or very near multi-year lows.

The Fed always tries to "look through" short-term price swings. That's why it focuses on the PCE core reading, which excludes the volatile food and energy categories. The trimmed gauges go a step further. Both eliminate statistical outliers, or extreme price moves, up or down, regardless of whether it's the price of gas or eggs or housing. Warsh told the Senate committee that as of March the underlying inflation trend was "quite favorable."

But there's a trade-off illustrated in the chart below. While the trimmed gauges are less reactive, especially the Dallas Fed's version, critics say they could leave policymakers behind the curve should rapidly rising prices become a trend. Even the Dallas Fed acknowledged this risk. As the chart shows, its trimmed mean frequently trailed the core PCE by a percentage point or more during the 2021–2022 inflation spike.  

So Warsh might have a tough time convincing his fellow Fed members to adopt a trimmed method as their north star, particularly at a time when policymakers are watching for signs that recent spikes in energy and fertilizer prices could drive broader inflation higher.

The first reading on inflation in April, two months into the Iran war, is due out this week with the release of the Consumer Price Index (CPI) on Tuesday and the Producer Price Index (PPI) on Wednesday. And early signs of oil driving broader inflation won't be the only thing the Fed is looking for.

In March, core PCE hit 3.2%, the highest level since November 2023, reflecting rejuvenated inflationary pressures that existed before the war started and that have nothing to do with energy prices.

For one, goods prices are moving higher again, with tariffs widely cited as a key factor. According to PCE data, goods prices rose 5.4% in the first quarter from a year earlier, the most in four years. Durable goods jumped 6.7%, also a four-year high. In March, goods prices rose 1.4% from a year earlier and accounted for 0.69 percentage point of the 3.2% year-over-year increase in the PCE index.