Elizabeth Warren and other lawmakers questioned whether Kevin could resist pressure from Trump

Wall Street is not confident about Kevin Warsh’s so-called reset at the Federal Reserve.

The reason is that Kevin told the Senate yesterday that he wants to change how the Fed reads inflation, but economists say his method could create a different problem instead of solving the current one.

Kevin, President Donald Trump’s pick for Fed chair, told lawmakers he wants the central bank to rethink how it measures inflation. The Fed now leans on the core PCE, short for the core personal consumption expenditures price index.

Warsh wants the Fed to cut out one-off price shocks

At his Senate hearing on Tuesday, Kevin also said, “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 then said he prefers “trimmed averages,” which cut off the most extreme price readings.

Kevin said, “We take out all of the tail-risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy.”

For now, that method makes inflation look softer. Aditya Bhave, an economist at Bank of America, said 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. The core PCE was 3%. At the hearing, Kevin called the inflation trend “quite favorable.”

But Bhave warned on Wednesday that this broader regime change at the Fed might not go the way Kevin wants. He said the switch could pull food and energy back into policy thinking in a bigger way, even though those categories are now excluded from the core PCE.

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

Bank of America says Kevin could get stuck with a hotter inflation reading

That is the problem sitting under the whole plan. If the trimmed method removes only the biggest readings, smaller price jumps can still stay inside the basket. Some of those increases could come from food and energy.

So even if the wildest spikes are cut out, the final reading can still come in above the Fed’s current preferred gauge. Bhave said Bank of America’s data shows this has happened before.

The bank said its trimmed-median inflation gauge was above the core PCE in 2019 and 2020. In those years, a trimmed basket would have pushed the Fed toward a more hawkish stance. Bhave said that if trimmed inflation rises above the core PCE again, Kevin would likely have to stick with the metric he chose.

Bhave said, “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.”

That has real effects because Fed rate decisions hit people quickly. Short-term borrowing costs, like credit card rates, usually track the Fed’s benchmark closely. Longer-term borrowing costs, like mortgage rates, depend more on inflation and other economic factors. When the Fed raises rates, borrowing gets more expensive for consumers and businesses.

That can cool the economy and ease inflation. When the Fed cuts rates, spending can pick up, but prices can also rise faster. Both high rates and high prices hurt consumers, so the Fed has to balance both.

During the hearing, Senator Elizabeth Warren and other lawmakers questioned whether Kevin could resist pressure from Trump to lower rates. Kevin said the central bank must stay largely independent from politics.

In his prepared remarks, Kevin said, “Monetary policy independence is essential.” He also said, “Monetary policymakers must act in the nation’s interest, their decisions the product of analytic rigor, meaningful deliberation, and unclouded decision-making.”

If you're reading this, you’re already ahead. Stay there with our newsletter.