Warsh's Biggest Challenge at the Fed: Maintaining the Fed's Credibility
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Kevin Warsh returns to the Federal Reserve as the new Fed Chair. His return occurs at a crucial time for the Federal Reserve, as its independence has been threatened multiple times over the past year. However, Mr. Warsh's greatest challenge may be preserving the Fed's credibility.
Mr. Warsh joins the Fed with controversial views on inflation measurement. Mr. Warsh advocates that policymakers move away from conventional inflation metrics and instead focus on "trimmed averages." This approach excludes the "tails," or the items with the highest and lowest price changes in a given month.
"Trimmed" inflation-like core measures are attempts to remove price outliers from the rest. However, inflation cycles are not linear; they include outliers and the composition changes over time.
But any effort by the Fed to alter the targeted measure would damage its credibility, as investors and analysts recall the Fed's actions in 2020.
In 2020, in response to criticism for consistently falling short of its 2% inflation target, the Fed introduced an "inflation-averaging targeting" framework. This approach would allow inflation to surpass the 2% mark to compensate for times when it was below target.
During the five years before inflation-averaging was implemented, the personal consumption core deflator was below target in four of five years, averaging 40% below target. Meanwhile, the consumer price index exceeded the target in three out of those five years, averaging just under 2%.
However, over the past five years, inflation trends have notably reversed, with both the personal consumption deflator and the consumer price index averaging several hundred basis points above the 2% target. This trend persists in 2026.
If the Fed opts to alter its inflation target while inflation is significantly above the target, especially after modifying the framework to promote more inflation and persistently low official interest rates when inflation was below target, it would set a bad precedent. Critics would argue that the new Fed Chair is adjusting the inflation target to squash calls for a rate hike, while opening up the possibility of an official rate cut later, which is what President Trump is seeking from his nominee.
Credibility is built by consistently following its mandate without retreating or changing targets, which can falsely suggest that you are taking the necessary actions to control inflation.
If Fed Warsh urged the FOMC to implement a new inflation target, he would risk significantly damaging both his and the Fed's credibility. Additionally, the bond market would strongly express its disapproval by substantially increasing long-term interest rates. What choice will Fed Warsh make: satisfy the individual who nominated him or prioritize the most important people, the investors?
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.