As supply-side shocks continue to pile up, the policy rift inside the Federal Reserve over inflation and employment is becoming more pronounced.
Speaking on Monday, Chicago Fed President Austan Goolsbee warned that supply shocks have become more frequent and longer-lasting in recent years, meaning the central bank can no longer simply look through them as temporary factors. If price pressures on the supply side keep spreading into a wider range of sectors, the Fed would still need to tighten policy to cool inflation, but the cost could come in the form of fewer jobs, lower wages, and slower economic growth.
Last Wednesday, the Federal Reserve delivered its first rate hike in three years and signaled the possibility of further tightening before year-end. Inflation has now stayed above the 2% target for five and a half consecutive years, and some officials are worried that tariff-related pressures and rising oil prices are transforming supply-side disturbances into more persistent price dynamics.
Goolsbee's remarks stand in sharp contrast to those of the new Fed Chair, Warsh, who said at the post-meeting press conference that reaching the inflation target does not necessarily require damaging the labor market.
Supply shocks are no longer just 'one-off events'
In prepared remarks delivered at an event in London, Goolsbee noted that supply shocks in recent years have arrived more frequently, with greater intensity and longer duration. If inflation driven by such shocks begins to show persistence, the logic of the Fed continuing to look through them no longer holds.
Previously, central banks typically treated supply shocks such as supply-chain disruptions and energy price spikes as temporary factors, avoiding rate hikes that could further suppress demand. But Goolsbee argued that these shocks are increasingly becoming a normal feature of economic activity, often lasting far longer than initially expected.
He cited three categories of pressure: supply-chain disarray, oil prices that have stayed elevated throughout this year, and escalating tariff frictions. In his view, if repeated supply shocks eventually turn into sustained inflation, the Fed still needs to act; otherwise, it risks failing its statutory duty of price stability.
Quelling inflation may come at the expense of jobs and wages
Goolsbee believes that even if inflation originates from supply shocks rather than excess demand, the Fed still needs to tighten policy to reduce demand and close the supply-demand gap in order to restore price stability.
That said, he stressed that such rate hikes do not need to be as aggressive as when responding to demand overheating, because the current problem is not purely one of excessive demand. However, as long as supply shocks persist, policy can hardly be painless: restoring balance to the economy may mean fewer jobs, lower wages, and slower growth.
Goolsbee described this as the painful trade-off between employment and inflation created by a stagflationary shock. When supply conditions keep deteriorating, the central bank cannot fully avoid harming both inflation and economic activity at the same time.
Fissures between the Fed and the White House are also widening
Goolsbee's stance contrasts sharply with that of Warsh. While Warsh voted in favor of the rate hike and framed it as pulling back some degree of accommodation to push inflation lower, he emphasized at the press conference that he does not see a fundamental mid-term conflict between the Fed's dual mandates of price stability and maximum employment, nor does he believe that hitting the 2% inflation goal must come at a clear cost to the labor market.
The White House, meanwhile, is applying more pressure on the Fed. After the rate decision was announced, White House economic adviser Peter Navarro publicly criticized the move, arguing that the Fed should not raise rates at the very height of an energy price shock, and called the decision the worst first rate-hike by any new Fed Chair in modern history.
As supply shocks drag on longer, the policy challenge for the Fed has shifted from whether to look through a one-off disturbance to how to handle what could be persistent inflationary pressure. And the question of how much of the burden of bringing inflation back to 2% will fall on jobs, wages, and economic growth is set to become the central issue in the Fed's policy debate.
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