Fed Faced with Limited Tools Against Inflation

The Federal Reserve is facing pressure to act against inflation, which has risen to 3.5%, above the 2% target but not as severe as it was in mid-2022. The new Fed Chairman Kevin Warsh has vowed to get inflation back to 2%. Some investors believe the Warsh-led Fed will show its seriousness about this pledge by raising rates as soon as Wednesday.

However, economists warn that rate hikes may not be effective in combating supply-driven inflation. Benson Durham, a former Fed official, said 'Rate hikes won't keep the bombs from dropping.' The war with Iran has disrupted energy flows from the Middle East, leading to higher prices for diesel, gasoline, and jet fuel.

Mark Zandi, chief economist at Moody's Analytics, argued that monetary policy 101 says when there is a supply shock, don't respond. He said 'That's a dangerous game to play. The labor market is weak and it wouldn't take a lot to push us into a recession.'

Jet fuel prices have risen due to the Iran war, contributing about 0.66 percentage points to forecasted inflation by the end of this year. Another 0.17 percentage points come from tariffs and trade restrictions.