Chicago Fed President Austan Goolsbee warned that the Federal Reserve cannot ignore the recurring and persistent nature of supply shocks, and must respond in a way that could potentially cause economic pain. In prepared remarks for a London event on Monday, Goolsbee stated that "supply shocks are coming more frequently, hitting harder, and lasting longer," and "once the impact of supply shocks on inflation becomes persistent, part of the logic behind 'looking through' them no longer holds." He added that while the Fed's response to these shocks and the resulting inflation need not be as aggressive as when addressing excessive demand, it would still not be without pain.
Goolsbee noted, "This is precisely the painful trade-off between employment and inflation that stagflationary shocks have always imposed on central banks. Unfortunately, in this environment, the only path back is the difficult one." Fed officials made their first interest rate hike in three years last Wednesday and projected one more increase by year-end. Policymakers are increasingly concerned about inflation, which has not reached their 2% target in five and a half years. Some echo Goolsbee's worries that price pressures are broadening beyond the supply shocks represented by tariffs and the surge in oil prices following the war in Iran.
Kevin Warsh, the Fed chair appointed by Trump earlier this year, characterized the decision as "removing accommodation" so that inflation can continue to cool. Goolsbee's warning comes as Trump administration officials repeatedly call on the Fed to maintain or even lower rates, using the traditional argument that supply shocks only have a one-time effect on prices. Peter Navarro, Trump's economic adviser, wrote after the Fed's rate decision, "Do not raise rates at the peak of the energy price shock. Warsh has now broken this rule, marking the worst first rate hike decision by any new Fed chair in modern history."
The Chicago Fed president acknowledged that since the 1970s, central banks have typically decided to "look through" supply shocks as temporary factors. However, he said that in recent years, such shocks have become a "constant feature" of the economy, and he expects them to last longer than initially thought. He cited post-pandemic supply chain issues, oil prices hovering near $100 a barrel for most of this year, and continuously escalating tariffs.
On suppressing demand, Goolsbee said that continuing to ignore recurring and persistent shocks "means failing to fulfill the price stability mandate." "If forecasts show large-scale, persistent and repeated shocks, the central bank still needs to restore price stability according to its statutory mandate, and the only way to bring down inflation is to raise rates and narrow the gap between supply and demand, even if this does not occur in the exact same sectors where the cost shocks originated," he said.
Goolsbee stated that while the Fed's response to current problems might not need to be as aggressive as with demand shocks, which tend to be more persistent, the economy may still need to experience declines in employment, wages, and growth because the Fed must cut demand. "After a persistent negative supply shock, achieving rebalancing requires people to adapt to a new, less favorable equilibrium, and wages need to fall," Goolsbee said.
These remarks contrast with Warsh's views. Although the new chair voted in line with the committee on the rate hike, he said at the post-meeting press conference that he does not see a need to harm the labor market to reach the 2% inflation target. "I do not believe the two parts of our mandate, price stability and maximum employment, will conflict in the medium term," he said.
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