Fed Chair Nominee Warsh & The Dumbing-Down of Inflation

Fed Chair Nominee Kevin Warsh intends to link the Fed's inflation target to median or "trimmed" price measures. These measures are a statistically manipulated version of reported inflation, creating an "alternative reality." They are the 2000s version of Arthur Burns' 1970s core inflation. If implemented, this would be the fourth time inflation measures used for policy have been dumbed down, primarily benefiting the finance sector, as it would create the impression of a lower underlying inflation rate, thus justifying low official rates.

Median and "trimmed" price measures remove the tails, or the items that record the highest and lowest price changes in a given period. These price measures are deceptive because they remove the extremes in the price distribution. During inflation cycles, the upper tail for items with significant price increases is much larger than the lower tail.

Median and "trimmed" price measures represent a more extreme version of former Fed Chair Arthur Burns' "core inflation," which excluded energy and food prices from the overall measure.

Government statisticians, with the help of Congress, have already removed the largest and most volatile core inflation items, house prices, mortgage and consumer loan interest rates, in the early 1980s and the late 1990s.

Under Greenspan's leadership, the Fed made another effort to dumb down inflation for policy purposes by selecting a hybrid price measure, the PCE deflator, as its preferred price target. The Fed never admitted that nearly one-third of the PCE price index is not derived from market prices or consumer-paid prices.

Choosing the PCE over the CPI was a convenient and potentially political method to produce a lower price index. This choice made it easier for the Fed to say it was achieving or close to its inflation target, thereby allowing it to maintain lower official rates than would otherwise be possible.

Price indexes are intended to accurately reflect the changes in the prices of the "conditions" they measure. However, government statisticians and Congress, with assistance from the Fed, continually alter these "conditions," not to enhance accuracy, but to create a lower index.

If Mr. Warsh is chosen to head the Fed, he is likely to succeed in adjusting the Fed's inflation target to these price indicators. The main beneficiary would be "finance," where Mr. Warsh previously worked, on and off, for the past 20 years.

The Fed advocates for its independence, yet how can it defend its "independence policy" when it implements or alters policies that mainly benefit industries where numerous members have worked or might work after leaving the Fed?