Federal Reserve Bank of Chicago President Austan Goolsbee warned the central bank cannot ignore repeated and persistent supply shocks, and must respond in a way that may cause economic hardship.
“Supply shocks have come more frequently, hit harder and lasted longer,” Goolsbee said Monday at an event in London. “And once supply shocks to inflation become persistent, some of the logic behind ‘looking through’ no longer holds.”
He added that while the Fed’s response to these shocks, and the inflation they’re generating, doesn’t have to be as aggressive as a response to overheating demand, it still won’t be painless.
“This is exactly the painful trade-off between employment and inflation that stagflationary shocks always impose on a central bank,” Goolsbee said. “Unfortunately, in environments like that, the only way back is the hard way.”
In remarks to reporters following his speech, Goolsbee added that if price pressures are also coming from overheating demand, the Fed’s median projection for one additional rate increase may not be enough to restore price stability.
Fed officials raised interest rates last week for the first time in three years and penciled in another increase before the end of the year.
Policymakers have become increasingly worried about inflation that hasn’t touched their 2% target in five and a half years. Some have echoed Goolsbee’s concerns that price pressures are broadening out beyond the supply shocks represented by tariffs and the oil-price surge that has followed the war in Iran.
Chairman Kevin Warsh, whom Trump appointed to the Fed earlier this year, framed the decision as removing accommodation so that inflation can continue to cool.
Goolsbee’s warning comes as Trump administration officials repeat calls for the Fed to hold or even lower rates, offering the traditional argument that supply shocks create one-time hits to prices.
“Don’t hike rates into the teeth of an energy price shock,” Trump economic aide Peter Navarro wrote after the Fed’s interest rate decision. “Warsh has now broken that rule — arguably the worst first rate-hike decision of any new Fed chair in modern history.”
The Chicago Fed chief acknowledged that since the 1970s, central banks have typically decided to “look through” supply shocks as transitory. But in recent years, he said, such shocks have become a “regular feature” of the economy, and he’s assuming they will last longer than initially thought. He cited the supply-chain issues that followed the pandemic, oil prices that have hovered around $100 a barrel much of this year and ongoing tariff escalations.
Continuing to ignore repeated and persistent shocks, he said, “implies failing the price stability mandate.”
“If the forecast calls for large, persistent recurring shocks, the central bank still has to restore price stability under its legal mandate — and the only way to bring inflation down is to raise rates and narrow the gap between supply and demand, even if it’s not in the exact same sectors where the cost shocks are occurring,” he said.
Goolsbee’s warnings came after softer inflation data in the summer made him optimistic that price pressures were fading. More recent data, coupled with what he’s hearing from businesses in his district, have increased his concern that demand in certain sectors is pushing up inflation, along with the supply-side forces.
“Up until recently I had thought mostly the AI data center part was staying in its lane,” Goolsbee told reporters after his speech.
Business contacts in his district, he said, particularly in manufacturing, have aired concerns that “sound like traditional demand overheating.”
Goolsbee said he’s still trying to discern whether renewed inflation is coming from supply shocks that will fade quickly or more persistent ones, or from increased demand for artificial intelligence and other services.
While the Fed’s response to the current issues may not need to be as aggressive as a response to demand shocks, which tend to be more persistent, Goolsbee said in his prepared remarks, the economy may still need to experience drops in employment, wages and growth because the Fed must reduce demand.
“For an economy to rebalance after a lasting negative supply shock, people would need to adjust to a new, less favorable equilibrium, and wages would need to fall,” Goolsbee said.
Those remarks clash with the views of Warsh. While the new chairman voted with the committee in raising rates, in his post-meeting press conference he said he didn’t believe it was necessary to harm the labor market to reach the 2% inflation target.
“I don’t believe that the two parts of our mandate — price stability and full employment — are working at cross purposes over the medium term,” he said.
Written by: Catarina Saraiva @Bloomberg
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