US inflation diffusion as a measure of underlying inflation: Nomura argues Warsh's inflation-diffusion measure is best used as a cross-check, not a primary policy guide

Overview

Nomura examines Chair Warsh's focus on the share of PCE components rising more than 3% as an indicator of underlying US inflation. The institution concludes that diffusion measures are informative about the breadth of price pressures, but core PCE and a broader indicator set remain more appropriate primary gauges of inflation trends.

Core views

Chair Warsh has highlighted inflation diffusion—the proportion of the 199 PCE price components rising above 3% on both a 12-month and six-month annualized basis—as a way to assess underlying inflation. Nomura agrees that the measure contains useful information about whether price pressures are widespread, and notes that both measures cited by Warsh remained above their pre-pandemic averages. But the report frames the policy question as how much weight diffusion should receive rather than whether it has any informational value. Nomura's central concern is construction. The figures cited by Warsh appear to use an unweighted measure, in which each of the 199 PCE components has an equal vote. Nomura defines a weighted diffusion index as the expenditure share of PCE categories with year-on-year inflation above 3%, while the unweighted index is simply the share of categories exceeding that threshold. This distinction is material because food, energy and core goods make up about 47% of components on an equal-weighted basis but only about 32% on an expenditure-weighted basis. Housing-related components, by contrast, represent roughly 16% of the consumption basket but only six components, or about 3% of the 199 categories; food represents around 8% of consumption but 22 components, or roughly 11% of the count. That composition causes the unweighted measure to put relatively greater emphasis on food, energy and core goods, which Nomura says are generally more volatile than services, especially after the pandemic. The unweighted diffusion index has therefore been more volatile than its expenditure-weighted counterpart and has swung substantially in recent years with energy and food prices and tariffs. A fixed 3% threshold adds a separate limitation: the index can rise either because the whole distribution of price changes shifts upward or because dispersion increases and pushes more observations into both tails. Those outcomes have different implications for underlying inflation. Nomura argues that the unweighted index may be useful when supply shocks are successive and persistent, but central banks generally look through temporary supply shocks or respond less aggressively than they would to demand-driven inflation. Greater reliance on the unweighted measure could therefore produce an excessive policy response to volatile moves that later prove transitory. The report consequently remains skeptical of making it the single most important policy guide. To test whether diffusion captures the trend better than conventional measures, Nomura compares weighted and unweighted diffusion indices with an average of three ex-post measures of “true” inflation: a centered 36-month moving average of PCE inflation, a forward 24-month moving average of headline PCE inflation, and band-pass filtered PCE inflation. The report notes that these measures were also used in setting trimming specifications for the Dallas Fed trimmed-mean PCE measure. The comparison finds little evidence that either diffusion measure identifies the underlying trend more effectively than core PCE. Around major turning points, including post-global-financial-crisis disinflation and the post-pandemic inflation surge, neither diffusion measure identified inflections materially earlier than core PCE. The report also compares diffusion with the Stock-Watson trend-inflation measure, which aggregates sector-level trends using expenditure weights and gives volatile sectors less influence when a smaller share of their price variation reflects the underlying trend. This contrasts directly with an unweighted diffusion index, which assigns the same importance to every component regardless of consumption weight or volatility. Nomura's conclusion is not that diffusion should be discarded, but that it offers another useful slice of the data rather than a superior real-time trend measure. Historical Federal Reserve and international practice supports that conclusion, according to Nomura. Fed officials have referenced diffusion when assessing whether disinflation or inflation had become broad-based: Janet Yellen did so during post-GFC disinflation, and Governor Waller and the 2022 Monetary Policy Report used simple and expenditure-weighted measures during the post-pandemic inflation surge. Yet diffusion generally remained supplementary to conventional measures, with core PCE widely regarded at the Fed as a strong predictor of future headline PCE inflation. The Bank of Canada, RBA, RBNZ, RBI, BNM, Bank of Korea and Bank of Japan likewise use variants of diffusion principally to assess breadth alongside broader suites of persistent- or underlying-inflation indicators; the ECB appears to use them less systematically. Nomura's bottom line is that not all inflation trends should receive equal weight. If Chair Warsh and other FOMC participants give the unweighted diffusion index more weight than core PCE and related measures, the report believes the risk of reacting to false signals would rise because of the measure's sensitivity to volatile goods-price movements.

Analysis framework

Nomura first distinguishes equal-weighted and expenditure-weighted diffusion indices and examines how category composition affects each measure. It then compares both versions with ex-post trend-inflation benchmarks and core PCE around major inflation turning points, before using Federal Reserve and foreign-central-bank practice as a cross-check on the appropriate policy role for diffusion.

Methodology notes

• Macroeconomics

  Inflation diffusion analysis

  The report measures the share of PCE components with inflation above a 3% threshold to assess how broadly price pressures are distributed, comparing equal-weighted and expenditure-weighted versions.

• Macroeconomics

  Ex-post trend-inflation benchmarking

  Nomura tests diffusion indices against a composite of a centered 36-month PCE average, a forward 24-month headline-PCE average and band-pass filtered PCE inflation to judge whether they reveal the underlying trend in real time.

Key data

• PCE components in Warsh's diffusion approach199The unweighted index counts the share of individual PCE components with inflation above 3%.
• Food, energy and core goods share47% equal-weighted; about 32% expenditure-weightedShows the larger influence these relatively volatile categories receive in the unweighted index.
• Housing shareRoughly 16% of the consumption basket; about 3% of the 199 categoriesIllustrates the underrepresentation of housing in an equal-weighted component count.
• Food-related items22 components, roughly 11% of 199 categoriesFood represents around 8% of the consumption basket but a larger share of the component count.
• Ex-post trend benchmarkCentered 36-month average, forward 24-month average, and band-pass filtered PCE inflationNomura averages these three measures to evaluate whether diffusion improves on core PCE.

Impact & implications

The report argues that inflation diffusion can help policymakers judge whether price pressures are broadening or narrowing, but should not displace core PCE or other underlying-inflation measures. An elevated policy emphasis on the unweighted index could increase the chance of overreacting to volatile, supply-driven price movements.

Risks

• A fixed 3% diffusion threshold can rise because price-change dispersion increases rather than because the underlying inflation distribution shifts higher.
• The unweighted index can amplify volatile food, energy and core-goods movements and generate false policy signals.
• Giving the unweighted diffusion index greater weight than core PCE could risk an excessive response to price changes that prove transitory.

What to watch

• Whether Chair Warsh and other FOMC participants increase their reliance on the unweighted PCE diffusion index relative to core PCE and other underlying-inflation measures.
• Whether price pressures become broadly based across PCE categories rather than concentrated in volatile goods-related components.
• The behavior of expenditure-weighted diffusion, core PCE and other persistent-inflation measures around future turning points.