Let’s be honest
The Fed Shouldn’t Overreact to an Oil Shock
The Federal Reserve has already made one major policy error this cycle. It shouldn’t compound it with another. The Fed should not raise rates!!
During Covid, the Fed invoked its emergency powers and effectively wrote a blank cheque for a massive fiscal expansion, absorbing a surge of government debt on its balance sheet. It did so in ways that aligned remarkably neatly with the priorities of the Biden administration, turning “independent” monetary policy into a willing partner for a de facto experiment in modern monetary theory.
In practice, the central bank validated a fiscal programme that the White House could not have financed on such a scale without a compliant Fed. That experiment in ultra-loose policy, coupled with aggressive deficit spending, produced the inflation that politicians tried to dismiss as “transitory.” The surprise was not that prices rose, but that so many officials claimed to be surprised when they did.
Today’s inflation scare is different. The recent uptick is being driven primarily by an energy shock linked to the Iran conflict, not a new wave of stimulus or credit excess. Before that shock, core inflation was clearly trending lower, and the underlying data pointed toward steady disinflation rather than a re-acceleration. In other words, the heavy lifting was already happening beneath the headline numbers.
That is why calls for the Fed to “get ahead of inflation” with another round of rate hikes are so misguided. Treating every adverse supply shock as a demand problem leads to the same reflexive response: tighten policy, prove your toughness, hope the models validate the move after the fact. But an oil spike that will wash out over months does not require the same reaction as a broad, credit‑fuelled boom.
Kevin Warsh will likely take over the Fed with one or two more hot inflation prints still in the pipeline as the energy shock feeds through. The temptation, in markets, in politics, and inside the institution, will be to use those numbers as cover for another hike. That would be a mistake. If core disinflation resumes as expected once energy normalizes, additional tightening now would mean squeezing an economy that is already cooling on its own.
The lesson of the Covid era should not be that the Fed must always do more, earlier, and with greater drama. It should be that misdiagnosing the shock leads to the wrong tool and the wrong dose. The last cycle’s mistake was to underprice the inflationary impact of fusing fiscal expansion with emergency monetary policy, in a way that blurred the line between technocratic judgment and partisan convenience. The risk now is the mirror image: overreacting to a temporary supply shock and locking in unnecessary damage to growth.
A Warsh Fed will have an early chance to show that it can tell the difference between Powell’s political legacy and a genuinely independent central bank, and between reflex tightening and the discipline of letting a temporary shock pass.