Viewpoints

Movements in the Federal Reserve Bank of Philadelphia’s state coincident indexes in March were generally muted. In the one-month changes, West Virginia led with a 1.12 percent gain, with North Dakota the only other state with an increase above .5 percent. Five states were down, but Hawaii’s .62 percent drop was the only one larger than .10 percent. Over the three months ending in March, while nine states were down, Hawaii was again the only one with a drop of as much as .5 percent. North Dakota, Indiana, and New Jersey were the only states seeing gains of 1 percent or more. Over the last twelve months, four states were down—West Virginia, which has clearly been quite volatile recently, was off 3.42 percent, but no other fell as much as half that. No state had an increase higher than four percent, and only three were higher than three percent.

The independently estimated national estimates of growth over the last three and twelve months were, respectively, .50 and 1.76 percent. Both measures appear to be fairly consistent with the state numbers.

India’s economic performance in 2025 exceeded expectations across the board. During our recent visit to Mumbai, nearly all contacts expressed surprise at the economy’s resilience. Despite the disruption from Trump’s tariff measures—under which Indian exports faced duties of up to 50% until an interim agreement was reached in February 2026—India still expanded by 7.6% in 2025, an improvement on 7.1% in 2024.

Growth did soften marginally in the final quarter, easing to 7.8% YoY from 8.3% YoY, largely due to weaker net exports. However, the more important takeaway for a domestically driven economy is that private demand strengthened (Figure 1). Consumption-led growth remained robust, and while export growth slowed, import volumes—a leading indicator of domestic demand—picked up significantly.

The Congressional Budget Office (CBO) projects large federal budget deficits, in absolute as well as relative terms, as far as the eye can see. This, by definition, means continued increases in the federal debt, again in both absolute and relative terms. The CBO forecasts that the levels of interest rates across the maturity spectrum over the next 10 years will be approximately where they are currently. My “forecast” is that the levels of interest rates, especially in the longer maturities will be higher than the CBO’s forecast. Be that as it may, the CBO projects that net interest on the federal debt will rise inexorably over the next 10 years. Given that Social Security, Medicare, Medicaid and defense expenditures are projected to dominate federal outlays excluding interest on the debt, there is little room for the federal government to slow the growth in federal spending without precipitating a walker-aided march on Washington, DC. By the way, it is projected by the Social Security Administration that its “trust” fund for old-age benefits will be exhausted by 2036. This means that all else the same, benefit payments to then current recipients will have to be cut. Do you really think “all else will be the same”? I think there will be a change in the law allowing the Treasury to borrow more to allow Social Security to maintain its “promised” benefits. Increasing taxes in a meaningful way appears to be politically unfeasible. Under these circumstances, I believe that the federal government, with “cooperation” from the Federal Reserve will attempt to inflate away its federal debt/debt-servicing challenges. It will do this by the Treasury purposely shortening the maturity structure of the federal debt and inducing the Federal Reserve, which dominates the level of short-maturity interest rates, to maintain the federal funds rate at a below-equilibrium level. This will result in a steepening in the yield curve, with the level of longer-maturity interest rates increasing relative to the federal funds rate as well in absolute terms. This will be accompanied by faster growth in the credit created by the Federal Reserve and the depository institution system, i.e., credit created, figuratively, out of thin-air (drink). In turn, this faster growth in “thin-air” credit will result in higher inflation.

Plotted in Chart 1 are fiscal-year observations of federal budget deficits (-)/surpluses (+) in absolute terms (blue line) and relative to nominal GDP (red bars). Historical data run from FY 1965 through FY 2025 and CBO projections are from FY 2026 through FY 2036. By FY 2036, the CBO projects that the federal budget deficit will be $3.1 trillion, compared with $1.8 trillion in FY 2025. As a percent of GDP, CBO projects the budget deficit in FY 2036 to be -6.7% compared with a median of -3.0% for fiscal years 1965 through 2025.

State labor markets were, yet again, generally little-changed in March. Three (Texas, Florida, and Tennessee) had statistically significant increases in payrolls. The sum of the changes across the states was 201,700; not very different than the (currently reported) national change of 178,000.

No state reported a statistically significant change in its unemployment rate. 26 states (including DC) had rates significantly different than the national 4.3%, although three of the four largest states (Florida, Texas, and New York) had rates not significantly different (indeed, the rate in Texas was 4.3%). Rates at or above 5.0% were in DC, Delaware, Nevada, California, Oregon, Illinois, Washington, and Michigan, with DC’s 6.3% the highest. Alabama, Hawaii, North Dakota, South Dakota, and Vermont had unemployment rates under 3.0%, while South Dakota’s 2.3% was the lowest in the nation.

Puerto Rico’s unemployment rate was unchanged at 5.6% and the island’s job count rose 1,800.

The surge in inflation in March is likely to be repeated in April and will continue as long as the Straits of Hormuz remains closed and energy inventories get tighter and tighter. The FOMC and its prospective new Chair have some work to do if they want to restore the Fed’s anti-inflation credibility.

The Cleveland Fed publishes a “nowcast” for the next CPI and PCE inflation releases. For the core they simply extrapolate the recent trend. However, for food and energy they look at actual daily data and hence they get a good estimate of what headline inflation will look like.

https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting

Recall that the consumer price survey is taken over the course of the month. Hence it reflects average prices rather than end-of-month prices. This is important today because food and energy prices rose over the month of March. Hence as the chart below illustrates, the CPI for gasoline will be higher in April than in March.

The report from the Bureau of Economic Analysis on the “core” inflation rate for personal consumption expenditures (PCE) in March was concerning. The monthly change in that price index was 0.4% for the third consecutive month, for a 3-month annualized change of 4.4%! The 12-month change climbed from a recent low of 2.7% in October to 3.2% in March, well above the Fed’s 2% objective. And don’t forget: the 12-month change understates inflation, given how the Bureau of Labor Statistics (BLS) treated shelter costs last October when a partial government shutdown prevented the agency from conducting its monthly survey of consumer prices.

A refresher. Lacking data for many items, BLS assumed their prices in October were unchanged from September. For most items this understatement was corrected the following month when November’s prices were correctly recorded, except for the price index for shelter costs.

BLS calculates the monthly percent change in shelter costs as the 6^th root of the percent change in shelter costs over the previous six months reported for one of six rotating panels within a larger sample of housing units. So, lacking survey data for October, the BLS assumed that shelter costs in October were the same as in April – the last time the panel scheduled to be surveyed in October was in fact surveyed – and then calculated October’s change in shelter costs as the 6th root of 0…equals 0! This understatement won’t be corrected until that panel is surveyed again in April. Until then, any change in shelter costs calculated over a span that includes October is missing a month of shelter cost inflation. If that span is less than a year but the change is annualized, then the understatement is annualized as well.

Let’s put numbers to this. The 6-month change in shelter costs was not recorded in October, but it was 1.65% (not annualized) in September. Let’s take that as an estimate of the true 6-month change in shelter costs for the panel that would have been surveyed had the government not been shut down. This implies that the price index for shelter costs has been low since October by 1.1065^1/6 – 1 ≈ 0.3%. Shelter costs have a relative importance of 35% in the consumer price index (CPI), implying that the CPI currently is low by 0.35*0.1% ≈ 0.1%, as is the 12-month percent change in the CPI.

On May 12 the BLS will release the CPI for April. No doubt it will show pronounced effects of higher energy prices, both direct and indirect, resulting from the closure of the Strait of Hormuz. However, it will also include the correction of the understated level of shelter costs. That correction will add approximately 0.1% to both the monthly and the 12-month percent change in the CPI, and slightly more than that to the corresponding measures of core CPI inflation. The impact on the price index for core PCE is roughly half this, given the smaller weight of housing in PCE than in the items covered by the CPI. So not only will the correction for the understatement of shelter costs boost reported inflation, it also will push the monthly change in the CPI above that for the PCE price index. None of this is earth shattering, but it is another reason to expect May’s inflation numbers to be unfavorable.

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?

While the press is filled with stories about the biggest oil supply shock ever and crippling gasoline prices, the economic data look fine so far. Nonetheless, I’m getting more, not less, worried.

So far, so good

The business press is loaded with stories about how the rise in energy (and related) prices is a huge shock to the economy. There are endless articles about how $4/gal gasoline prices are devastating to households. And perhaps warning comes from none other than the International Energy Agency. They are all over the press arguing that this is “the largest supply disruption in the history of the global oil market.”

And yet, seemingly miraculously, the US economy seems fine. Most March indicators were solid. Payrolls surprised to the upside and jobless claims remain low by historical standards. suggesting low layoffs. The various purchasing managers indexes are healthy. The only ugly data is the chronically weak consumer confidence surveys. Overall, trendlike growth of 2% or so seems to continue. What gives?

Time

The first thing to note is that there are lags between the onset of the shock and the impact on the data. It takes time to change behavior—people tend to look through temporary shocks. Moreover, current data releases measure where the economy was in the middle of March. April data should show some (small) impact.

A small shock so far

Despite the warnings from the IEA, so far this is a small shock by historical comparisons. It makes no sense to measure an oil shock looking only at the peak amount of supply disrupted. The duration of the disruption is more important. It is the cumulative amount of oil taken off the market that matters. A short disruption is cushioned by inventories and the consumer response to a short price spike will be small. The size and duration of today’s price shock isn’t even close the recent Russian shock, let alone the 1970s oil shocks (chart).