Ethan Harris is a longtime economist and Fed watcher as the author of “Ethan on the Economy: Independent Views from an Unvarnished Economist,” a blog that posts on LinkedIn regularly and is now published on Substack as well.
No surprise that his career started at the Federal Reserve Bank of New York where he was Head of the Research Division. And continued on the financial markets side of his career path when he became U.S. chief economist at Lehman Brothers and Global Head of Economics at Bank of America.
He joins me as Kevin Warsh is taking over as chair of the Federal Reserve and the debate is as hot as ever over where he will try to lead his 18 fellow policy makers on the Federal Open Market Committee.
Ethan thinks Warsh’s views are going to change a lot when he’s on the job and sits at the head of the FOMC’s policy meeting table. “There's a big difference between campaigning to be the Fed chair and being the Fed chair. You need to run a committee. You need to convince a majority vote. And you're now in.”
Referencing Warsh’s years as a Fed governor from 2006 to 2011, Ethan says “he's going to learn… it's very different to be a governor than it is to be the chair. He's got to <know> there'll be some convergence, there'll be some reform at the Fed. But I think Warsh is going to dramatically soften some of his criticisms” he made of the Fed in the recent past and become a consensus builder now.
As for interest rate cuts that Warsh had supported while he was in the race to be appoointed by the president, Ethan predicts the new chair will realize the current situation of high and rising inflation has changed and rules out any such moves now.
Ethan sees three windows that will potentially open and lead the Fed to hike rates this year. “The first would be if the bond market starts to be unanchored,” he says as it prices in higher inflation and “inflation expectations are going up” with the market in effect saying “if you don’t do anything we’re going to sell off even more.” The next would be by summer’s end if and when the inflation keeps rising, and the third would be after the elections in December when that door opens to rate hikes as well.
Of special interest to me is Ethan’s longtime interest in, and support for, using trimmed mean inflation measures to gauge price trends when analyzing and setting monetary policy, a focus he has brought to our previous conversations about inflation on Central Bank Central. And this has been well before Chair Warsh put trimmed mean measures in the spotlight over the past year as a gauge that is more accurate than the consumer price indices and for the PCE that is used in the U.S. to gauge inflation, and determine whether or not the Fed is hitting its 2% target.
Ethan is clear that while the trimmed mean is a useful indicator, it should not replace headline PCE inflation as the Fed’s official target. “It’s not credible for the central bank to say, oh, we’re targeting trimmed mean or the core excluding food and energy. It just undercuts their credibility. Inflation is inflation. And they want to target the number that the, that Americans actually experience.” That doesn’t mean the trimmed mean is not useful to the Fed.
”Now, with that said, they need to have indicators to help predict headline inflation. And that’s where these core measures come in, including the trimmed mean, those indicators, lots of studies show, tend to help predict future inflation.” Harris points out that the trimmed mean helps filter out temporary shocks and provides insight into underlying inflation trends, making it a valuable tool for policymakers.
So dive in and hear more about where Ethan sees inflation heading over the course of the year. Spoiler alert: He observes that recent data show inflation picking up, even in core and trimmed mean measures, which has shifted the Fed commentary from dovish to more hawkish. He warns that the persistence of inflation, combined with external shocks like energy prices, means the Fed is more likely to hike than cut rates in the near term.
Warsh: an agent of change 00:01:35:01
We need to remember that Kevin Warsh was a leading critic of the Fed before he was, appointed. So he comes in with a very strong, reform agenda. I think what we need to keep in mind is that there really is going to be a convergence between him and his committee. He will get some reform in, there’s no question that there are elements of what the Fed does that could, use some changes.
Warsh will change: Mr Inside and Mr Outside are different people 00:02:02:20
And I’ve been up and down in my views of the Fed, particularly in the last six years or so, at times quite critical at times quite happy with them. So there’s going to be some, reexamination of the way the Fed does things. But I think Warsh is also going to change a lot on the job. There’s a big difference between campaigning to be the Fed chair and being the Fed chair. You need to run a committee. You need to convince a majority vote. And you’re now in. Whereas outside the Fed, he’s kind of a one man show at the Fed. He’s got in his fingertips a massive amount of information and ideas and intelligent people. So he’s going to change too. He’s going to learn about, it’s very different to be a governor than it is to be the chair. He’s got to there’ll be some convergence, there’ll be some reform at the Fed. But I think Warsh is going to dramatically soften some of his criticisms.
A difficult time to take over at the Fed 00:03:07:11
Well, the starting point is remember he’s coming into a hot seat there. I mean, it’s a really challenging time. You’ve got all kinds of cross-currents in the economy. You’ve got the AI boom that may generate a productivity surge, but then you have all kinds of negative supply shocks going on with the war, with trade, with immigrant policy. So you’ve got to sort through, this very diverse kind of set of information.
Number-One: Can’t cut rates now 00:03:37:10
I think that probably what he’s going to find, the first thing he’s going to find is that he can’t cut rates. You know, it’s one thing to argue that for rate cuts down the road, once you’ve kind of proven that productivity is really picked up, but it’s another thing to do it. Now, the Fed has very serious credibility issues right now about managing inflation. As Warsh himself has pointed out, you can’t come in in that environment, and the first thing you do is say, don’t worry, productivity is going to rescue us. No reason for the Fed to be worried about inflation that. So I think that, all this talk about how he’s going to get the Fed to cut rates, a lot of that’s gone away now…
On the job learning 00:04:29:05
He’s not going to be able to get rate cuts out of the committee. And so I think that the I mean, getting into the weeds about these questions around what the Fed can and can’t do and how to manage, their reputation, I think, will be an area where he learns a lot on the job.
Waller looks at the situation and makes up his mind 00:06:23:01
…They think of Waller as being a dove, but I don’t think he’s a dove. I think he’s a situational hawk and dove. In other words, he really does do what you’re supposed to do as a Fed official. You look at the data in the forecasts and you decide, okay, I’m going to use their favorite cuts or hikes. And he’s changed his view because he started the year thinking that a break in the labor market was the biggest risk and that we could get some string of negative payroll numbers. And now he’s looking at the data saying, well, the labor market doesn’t look that bad. It’s weak, but it’s not about to collapse. But we’re seeing some very unfriendly inflation readings, not just the headline but a lot of different measures of inflation.
Waller in the middle 00:07:13:03
So he’s moved from being very much on the dovish side of the committee to, I would say right in the middle. I think the middle of the committee now we’ll learn this at their next meeting is to do nothing for a long time. Right. It’s really going to cling. They’re going to cling to this idea that we need more information.
Waiting for good-clarity 00:07:34:09
We’re not going to move until we have real clarity around the fact the economy’s avoiding recession and the fact that it’s avoiding another bout of sustained high inflation. So he’s moved to the middle. He’s saying we could go either way. And I said I agree with him I think so do.
Policy often is personal judgement 00:08:25:08
…The committee’s got to do it’s got to do. Right? I mean, we can’t - they can’t - be looking behind their back <asking> is the president going to criticize us in a big way? Is Kevin Warsh a hawk or a dove? They’ve got to do what’s in their own mind.
I mean, that that has been what we’ve seen up to now as well. I mean, Powell is his own man. You know, he was willing to push back against political pressure. I think he has, in a sense, instilled that same kind of backbone in the rest of the committee. They’re going to do what they think is right.
Are the vigilantes prepared to start a new vigil? 00:09:09:07
There’s no there’s no other way. Okay. They’re there. There’s no easy choice. If they bill, if they if they, give in to pressure to cut, they could really crater the bond market. Yeah. And the bond vigilantes have been kind of in hibernation for years, but they’re starting to, to poke their head up out of the ground.
Is Warsh’s predicament really this fragile? 00:09:33:18
If they if they hike soon, of course, the honeymoon will be over for, Warsh and the attacks on the Fed will resume. But there’s no easy choice.
Three windows for a Fed rate hike 00:11:32:07
Yeah. I think that the, there’s pretty good better than even odds. I’m not going to be a hedging economist. I think there are three windows for the Fed to hike this year. So, I THINK THEY WILL DO A HIKE. The first would be, if the bond market starts to be unanchored. If you start to see in the next few months that the bond market is pricing in higher inflation, inflation expectations are going up.
You could get a pretty quick hike under those circumstances because in a sense, the bond market would be saying, if you don’t do anything, we’re going to sell off even more. The second window would be further out. And by September, if you’re still in this environment where inflation seems to be a bigger problem, then, that would be a second opportunity. And then they probably do not want to change policy right around the election. So the next opportunity would probably be December. I can see three scenarios. And the reason I’m fudging here at all that is because I’m a little - let’s be honest - this is an extremely hard call to make. But I do think, I’m on the side of the consensus.
A new asymmetry: More likely to hike than to cut 00:12:51:19
I think they’re more likely to hike, than cut and I see these three windows as potential, potential opportunities.
Inflation: PCE is the target 00:13:40:11
Well, I think the starting point is that whatever the Fed does in terms of the indicators, it’s focused on the target for inflation: that is headline inflation. It’s not credible for the central bank to say, oh, we’re targeting trimmed mean or the core excluding food and energy. It just undercuts their credibility. Inflation is inflation. And they want to target the number that the, that Americans actually experience.
One target but some forecast-helper 00:14:10:21
Now, with that said, they need to have indicators that help predict headline inflation. And that’s where these core measures come in, including the trimmed mean, those indicators, lots of studies show they tend to help predict future inflation. They tended to attempt to get to the underlying inflation, remove temporary shocks, and in that way, help forecast where inflation is heading in the next year or two.
The trimmed mean has flaws, too 00:14:42:04
On that basis, we should be looking at, I think it’s a trimmed mean. The trimmed mean has was developed at the Fed at the Dallas Fed. It’s had a long history. A lot of work has gone into it. And it is a good predictor of future inflation. However. And there’s a caveat here and that is that right now research at the Fed, including by the same economists who developed these indicators, shows that there’s some distortions in the trimmed mean, and I’m not going to get I’m not going to kill your audience by getting into the technical details, but you’re trimming out the ends of the distribution, the really high and the really low numbers and the way they trim it out is very sensitive to whether the distribution has a big high end or a big low end to it. So it’s about the this kind of the weird behavior of the distribution. So they’ve looked at this, they’ve determined that the best measure of underlying inflation is probably a little higher than the trimmed mean.
Fed still too much of a black box on deliberations 00:15:48:05
But we should be paying attention. And indeed the Fed before FOMC meetings, the Fed looks at a bunch of indicators of core inflation. And that’s what they should be doing. But I think they need to be more public about this. Talk about the why you’re looking at these things. They’re not targets. They are things that help you forecast.
Core still too high 00:16:08:06
They’re they combine with models. They help be forecast. We’re inflation’s going there. And so as part of that discussion the trimming should be included. My sense is that true core inflation. If you kind of look at the objective take an objective look at these indicators is a little below three but still well above target.
Inflation looks broad
Yeah. And also, you know, if you one of the things that’s a bit disturbing lately is if you look at the monthly data, and you look at the annualized growth in recent months, very high even for, well, even for all of the core measures. So it doesn’t seem like it’s a super isolated oil related spike. It’s looks like it’s the inflation pick up we’ve seen since the start of the year is the mixture of the energy shock and some underlying inflation increase - that is concerning. That’s what’s got the Fed going from dovish to hawkish okay.
Trimmed mean- false signal of happiness a year ago.. 00:17:25:16
I mean if you look at the trimmed mean PCE. You know late last year it had a period where it was basically on target. So if you wanted to, you could kind of declare victory if you thought that was your best place. Since then it’ creeping up again. And so the monthly numbers have been coming in a two and a half, 3%. So it’s not, it’s, it’s not confirming the friendly signal it made late last year. It’s kind of moved away from that. So this is I think the Fed correctly spots that and says, you know what. We should not have an easing bias. And I think that easing bias will definitely, go away at the coming meeting.
Another allegation of bad Fed communication 00:18:23:19
Yeah. I think that, you know, it’s not a new idea. This has been around a long time. There are other central banks that emphasize a range of core indicators. Bank of Canada Bank, central Bank of Australia. They are the reserve Bank of Australia. There are a lot of banks that look at these indicators. What do you think the Fed needs to do is communicate better?
PCE core is a bad number 00:18:47:05
They shouldn’t… have elevated the traditional core to this place so high that it’s actually four <4%> forecast, they only forecast a few different numbers. And one of them is the, the traditional core, which is a relic. It’s it shouldn’t be on that forecast sheet that they all put out, in the SEPs. So they should deemphasize that and start talking more about the range of underlying inflation indicators.
Glow is off the economy lots of special forces 00:19:51:16
The economy is muddling along, in a very uninspiring way. But it, you know, behind the scenes is a lot of conflicting, currents, crosscurrents or the economy’s getting hit from all angles. If you look at, the data over the course of the last, you know, 5 or 6 quarters terrible first quarter of last year as imports flooded in the U.S., great second and third quarter, partly as a rebound from the first quarter, lousy fourth quarter, partly due to the government shutdown and then a very disappointing rebound in Q1. I mean, the history of government shutdowns is they’re transitory, and you usually get a big quarter after the bad quarter. We didn’t we now have it, revised down to 1.6%. And now going into the second quarter, it looks like a similar kind of slightly below 2% quarter. So the economy is really gotten stuck in the mud here. It’s not terrible. You know, the labor market is very weak. But part of that is because of immigrant reduction policy. Part of it’s due to just a not very inspiring growth picture. But, you know, the economy’s muddling along now. I would say that’s actually a pretty good outcome given the scale of shocks hitting the economy.
Running the gauntlet and still growing 00:21:23:11
I mean… we’re getting hit left and right. You know you got an energy shock now. You had a trade war shock. You’ve had, the reduction in the labor force from immigrant enforcement. You had climate events, you know, you name it. They happened and the economy still growing at close to 2%.
A two-cylinder economy AI and the Rich 00:21:46:02
That’s actually encouraging. However, as you’ve probably heard from other guests, it’s a fragile 2%. It’s not a solid 2%. We’re way too dependent on the AI investment boom and very high spending by upper income households. Those two things are basically the two drivers of this economy. Everything else looks very weak and so I do worry about the fragility going forward that, you know, if the equity market, we’re to have a big correction or if the AI boom kind of started to fade, you know, what takes the lead then? So it’s a muddle through, fragile expansion.
End of the war…right 00:23:38:04
Yeah. I mean, somebody, described it as Charlie Brown kicking the football with Lucy. You know, she pulls the football back at the last second every time. I mean, there have been maybe 30 false signals and an end to the war… where it’s kind of, It’s soon, we’re almost there.
Think Strait not war 00:24:01:20 -
And so anyone who’s being, realistic has to be extremely uncertain about when it actually happens. And the important thing to remember is that it’s not so much the end of the war. It’s the reopening of the Straits is by far the most important economic news out of the war. If there’s a few missiles going off here or there or whatever.
Longer closure means more risk 00:24:26:11
But the closing of the Straits is, is a slow motion disaster for the global economy. It’s means that we have a steady, decline in oil inventories globally. And then at some point, time is not on our side. At some point, that shrinkage of inventories is going to cause another big spike in energy prices. So the longer it goes on, the greater the risk of a second, spike.
Probably some opening coming, but not a problem solver 00:24:53:07
Now, in terms of the way the Fed reacts to this and you know, what they should be doing. And by the way, I might just answer your question. My guess is that we’ll get some kind of ceasefire in the next few months, and those straits will at least partially reopen. But even with that, I think you’re going to have this inventory shortage hanging over the market for a long time now for the Fed.
Two stages to an energy shock 00:25:21:11
It’s always important to understand there’s a two stage reaction of a central bank to a energy shock. The first stage is watch and learn, because you don’t know what war you’re fighting. Are you fighting a recession problem or an inflation problem? So what do you do? Well, you put your on your, you know, binoculars and you look at every little indication of which of those problems is the bigger problem. Is it is the war, the shock to incomes, in real spending power, or is that really crushing the consumer, or is the consumer kind of shrugging it off? So far, consumer’s been able to shrug it off, but who knows how long that lasts. And, and the other side is the, the surge in prices causing people to start expecting serious high inflation going forward. Does it unanchor inflation expectations? Does it spread broadly across the economy? You know, those are the kind of things you’re looking at, right now. The energy shock or the, the inflation shock is looking worse than the growth shock. And so that’s why I think that the Fed’s more likely to hike them to ease going forward because the, the shock seems more of an inflation shock.
Biggest supply disruption in history 00:27:31:12
I think the right analogy, which you’ve probably heard from others, is up like a rocket, down like a feather. Thank you. So so here’s the here’s the problem. Despite all the hand-wringing and all that, energy prices have gone up that much. This is the biggest supply disruption in history. But oil going up to $100 isn’t great.
Bigger shocks in the past 00:28:00:13
Right. It’s well short of previous shocks. I mean, the shocks of the 1970s were much worse in real terms. And even the Ukraine, war was less of a shock. So what’s happened is that people have been willing to look through the supply disruptions, and so prices haven’t really gone up that much. The problem is that when you come out of this, it’s going to take six months or a year to restore inventories and get the oil market back to normal.
Transitory with lingering adversity 00:28:34:18
So the drop-off in prices is not what the Trump administration is saying. It zooms up and it collapses on the other side. It’s going to zoom up and then there’ll be this gradual downward trend in energy prices. So, you know, you can call that, you can say it’s a transitory shock, which is true in a sense, but there’s also a lingering, persistent impact.
Some price increases related to energy are being postponed 00:28:57:18
The other thing I’d worry about is that we know that at least some companies have been absorbing the energy shock and not passing it through to customers. They can’t do that forever, you know? And so, there could be another round of, of, you know, pass through, going forward, even if energy prices are starting to fade. So it would be great news if they get the Straits reopened.
Powell as a dovish Fed chair/bad framework shift 00:30:41:03
Yeah. So, I think that Powell has been a dovish leaning Fed chair, as you say. He seemed to be more worried about the unemployment rate than inflation. The 2020 framework the Fed announced I really did not like that. It went from a balanced framework where they focus on both inflation and unemployment equally to one where they explicitly announced that they’re going to experiment with how low they can get the unemployment rate. I really do not like the I thought the, old framework was much better. And in fact, I think that the framework contributed to the big mistake in 2021, 22 when they didn’t hike soon enough. So I think that that was an episode where, they got off track for a while, but they’ve for the most part, they fixed it.
Some of what Warsh has warned has already shifted 00:31:38:17
Right. The 2025 framework basically rolled back the clock. It got rid of references to diverse and inclusive labor market. They don’t talk about climate change anymore. And most important, they talk about the, the, the mandate in a symmetric manner. So they’ve moved back to where they should have been, in the first place. So some of the movement that that Warsh is calling for has already happened.
Warsh may be more dovish in his own way 00:32:37:16
Coming out of the great financial crisis, when he opposed the Fed’s easing and QE. Now he’s like saying okay, AI is going to save us. We don’t need to hike. In fact, we should be cutting rates. So, my view of him is that he’s actually slightly more dovish initially than Powell was. And I like to see a Fed chair come in and say, hey, wait a minute, we screwed up and we’re going to fix it. Not by hoping for productivity to save us, but we’re going to bring inflation down. And oh by the way, it’s not the end of the world if inflation goes slightly below target. Right. You’ve overshot by 11% over a five year period. Why is the Fed so determined to not undershoot. What is why is that the end of the world when you’re facing an inflation, credibility problem?
Ethan defines ‘hawk’ 00:33:34:04
So that kind of acceptance of that is the goal for the next few years is dovish in itself. Why aren’t they saying, oh, if we go to one point 8, or one and a half, or something like that. All right. Good. We completely restore our credibility if we do that. But no, that’s not what they’re doing. And Warsh doesn’t talk about that either. If he was a hawk he would be talking about that. He’d be saying, we’ve overshot. We need to prove ourselves.
Fed is not very introspective 00:34:23:00
Oh yeah. We’re facing a examination period for the Fed. And that’s always good. You know they just did their 2025 framework. But their framework discussed I mean, again, I don’t want to be too critical of the Fed, but their framework discussions have never been very in-depth. Other central banks, like the Bank of Canada, when they do their framework discussion, they’re asking all kinds of hard questions, and they’ve got papers coming out.
The Fed balance sheet question 00:34:50:18
The Fed seems to kind of like tiptoe around a bit. And so the 20, the change from 20 to 25 was a good thing. But there also needs to be their need. Some of the questions of wishes asking should be asked. Do we want a you know, high reserve system for the banking system. We want to have a big balance sheet. That’s a reasonable question to ask. Yeah. And if we don’t want a big balance sheet, how are we going to move it down without disrupting the markets? That’s a perfectly reasonable, question to ask.
ETHAN HARRIS
Former US Chief Economist at Lehman Brothers and Global Head of Economics at Bank of America. Previously, Head of Domestic Research Division at the NY Fed. Ethan holds a Ph.D. from Columbia University and is the author of “Ben Bernanke’s Fed.”
