Warsh's Inflation Warnings May Be Exaggerated

Financial expert Kevin Warsh has been vocal about his concerns regarding inflation, but a closer look at the data suggests that his views may be overly pessimistic. In a recent speech, Warsh highlighted a chart showing that more than half of the categories within the Fed's preferred inflation gauge, the core PCE deflator, are experiencing inflation above 3%. However, critics argue that this chart is flawed because it doesn't account for weights, which can greatly impact the overall picture.

A closer examination of the data reveals that goods prices account for virtually all of the worrying shift in the distribution of price increases. Many of these goods have small weights in the overall basket, and a significant portion of this inflation is due to tariffs. However, as the Supreme Court's ruling against large parts of President Trump's emergency tariff program earlier this year has led to a decrease in tariff revenue, it's likely that this will no longer be a source of inflationary pressure.

Furthermore, service sector categories running above 3% inflation remain well above pre-pandemic norms and have shown little progress. However, influential Fed Governor Chris Waller suggests ignoring imputed prices, which are often used to estimate the cost of services that aren't directly measured. When these imputed prices are stripped out, market-based core inflation runs roughly 0.3 percentage points below the headline core PCE figure.

One alternative measure of inflation is 'trimmed mean' inflation, which strips out categories with the highest and lowest inflation rates at any given time. According to Warsh himself, this indicator has fallen in recent months and now sits close to the Fed's 2% target.