Fed's Warsh Faces Inflation Conundrum: Can Rate Hikes Fix Supply-Driven Prices?

The Federal Reserve is under pressure to act on inflation, but its tools may be limited. Kevin Warsh, the new Fed chairman, has vowed to get inflation back to 2%, and some investors suspect a rate hike as soon as Wednesday. However, the Fed's ability to combat supply-driven inflation is questionable.

As Benson Durham, a former Fed official, noted, 'Rate hikes won't keep the bombs from dropping.' The war with Iran has disrupted the flow of energy from the Middle East, driving up prices on diesel, gasoline, and jet fuel. High tariffs have also contributed to higher costs for some goods.

Mark Zandi, chief economist at Moody's Analytics, said that monetary policy 101 dictates that when there is a supply shock, don't respond with rate hikes. Instead, follow the script and let prices adjust naturally.

Zandi warned that raising rates could tip over the stock market and push the economy into recession. Former Fed Chair Janet Yellen also argued that the default strategy should be to 'look through' supply shocks, rather than being tempted into rate hikes.