Hours before Kevin M. Warsh gave his first testimony before Congress as chairman of the Federal Reserve on Tuesday, he received some good news.
Inflation had finally cooled after a series of sharp increases raised the annual rate to a three-year high this summer.
The respite was visible not only in the overall measure of inflation, which was driven by a sharp drop in energy prices after a preliminary truce to end the war with Iran. It was also noted in the “core” indicator of the Consumer Price Index, which excludes volatile food and energy. Those prices remained stable during the month, reducing the year-on-year rate to 3.5 percent.
Monthly data is always analyzed closely. But in the days leading up to Tuesday’s release, it had taken on greater significance. Christopher J. Waller, governor of the Federal Reserve, said Monday that a “hot” report would have forced the central bank to consider raising interest rates “in the near term.” This was understood at the next Federal Reserve meeting on July 28 and 29.
The better-than-expected data was supported by a report on Wednesday that showed wholesale prices fell sharply. Taken together, that has quelled calls for an imminent rate hike. However, it has not eliminated the possibility in the future, keeping Warsh, who has staked his reputation on reducing inflation, under pressure to demonstrate his commitment to meeting that goal.
“Undoubtedly, the softer-than-expected data lengthened the runway available to Warsh and his colleagues to consider the situation and reflect on whether they are really going to cross the Rubicon of raising the funds rate,” said David Wilcox, a senior fellow at the Peterson Institute for International Economics and former leader of the Federal Reserve’s research and statistics division.
“It seems to me that Warsh and his colleagues will most likely have to put their money where their mouth is and toughen their political stance.”
What the Fed ends up having to do depends directly on the trajectory of inflation, a point several top officials made clear this week. Some seem more patient than others.
Lorie D. Logan, who as president of the Dallas Federal Reserve Bank is a voting member of the committee that sets policy this year, called Thursday for “modestly higher” interest rates to “finish the job of restoring price stability.” That suggests that the Federal Reserve’s Sept. 15-16 meeting will include, at a minimum, an active debate on the issue.
Lisa D. Cook, governor of the Federal Reserve, suggested Wednesday that if she saw no signs of disinflation “soon,” she would be “prepared to act.” His comments followed a warning from John C. Williams of the New York Federal Reserve, who told reporters earlier that day that if inflation proved more persistent than he expected (he had predicted a slowdown in coming quarters) then the Fed would have to adjust rates. And Waller said he would need to see several months of lower inflation data to continue to keep rates stable.
According to many of these officials, there is still a way for inflation to resume its decline to 2 percent. Energy prices, although rising again due to the new escalation of the war with Iran, are still below their recent highs. The impact of tariffs is no longer as pronounced as before. Rental costs and other housing-related expenses, which make up a large portion of the overall CPI index, continue to rise only modestly. Perhaps most importantly, the labor market is not a source of inflationary pressure.
In this context, Tom Porcelli, chief economist at Wells Fargo, said the Federal Reserve could afford to be patient in raising rates and questioned the effectiveness of taking any action.
“If these supply-side shocks are impacting inflation, then there is very little the Fed can do about it,” he said.
But the risks are palpable, as officials and economists alike repeatedly stress. For one thing, some of the categories that helped keep June’s inflation data in check may not be as subdued going forward, said Omair Sharif, founder of Inflation Insights, a forecasting firm. That includes airfare and hotel rates, auto and used car insurance, as well as wireless services, which he said could contribute to “some bumps in the road ahead for core inflation.”
The war with Iran is also far from resolved, and the Trump administration imposed new tariffs this week. Another concern arises from artificial intelligence, which John Roberts, who worked for more than three decades at the Federal Reserve, described as a “wild card” for the central bank. Booming demand amid limited supply has driven up prices for a variety of products, including semiconductors, computer chips and servers.
In an exchange Wednesday with Sen. Jack Reed, D-R.I., Warsh admitted that increased investment in AI could drive up prices in the coming year. “Whether that’s inflationary or not, that’s up to the Federal Reserve,” he said.
That answer is one that Warsh commonly uses. This week he explained to lawmakers that he would deliver on his promise to reduce inflation with a three-pronged strategy: affirm the Fed’s commitment to meeting its goal, take responsibility for any inflation failures, and consider whether the Fed can adjust its tools “to meet it head-on.”
However, Warsh’s decision to deliberately obscure his thinking on the trajectory of rates has made it difficult to determine where he sets the bar for raising borrowing costs compared to his peers.
In doing so, said Wilcox, who is also director of U.S. economic research at Bloomberg Economics, Warsh “invites the interpretation that he might believe that he can will that outcome into existence.”
For Warsh, a set of five working groups he has created to examine a range of policy issues will play a central role in helping determine the Fed’s next steps. When Sen. John Kennedy, R-La., pressed him Wednesday to fix the Federal Reserve’s inflation problem, Warsh invoked his working groups, which he said would “get to the big, hard questions, rather than trying to cover it up with policies that haven’t proven to be successful.”
Warsh has hired more than a dozen former policymakers, academics and business leaders to serve as outside advisers. He has paired each group with two Federal Reserve staff members, one from the board in Washington and another from regional banks, according to people familiar with the matter. The staff members, who have been instructed to act as a bridge for outside advisers to help them logistically, such as identifying relevant research and making internal connections, include senior central bank economists, many of whom have worked there for years, the people said.
The stakes are high for Warsh, given his repeated claims that the Federal Reserve will not stop reducing inflation.
“He’s put his own reputation on the line by saying, ‘I’m going to turn this ship around,'” said Derek Tang, an economist at research group LHMeyer.
