Fighting inflation likely to be ‘painful,’ U.S. Fed official says

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A top Federal Reserve official said Monday that the central bank may have to cause economic pain in the form of higher unemployment to combat stubbornly high inflation.

Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said in a speech in London that the Fed is facing a series of persistent supply shocks that have driven up inflation, including higher oil prices from the Iran war and tariffs. Typically, Goolsbee noted, the central bank would essentially wait for such shocks to fade and inflation to fall on its own rather than raise borrowing costs.

But faced with an ongoing series of persistent supply shocks, the Fed now has little choice but to hike rates, Goolsbee said. The increases are needed to lower consumer and business demand to a level consistent with reduced supply, he added, which should bring inflation back to the Fed’s two per cent target.

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“The only way to bring inflation down is to raise rates and narrow the gap between supply and demand,” he said in a written copy of his remarks. “Forcing inflation back to target in the short run means pushing employment below target. … In the short run, supply shocks force a difficult trade-off” between the Fed’s goals of low inflation and maximum employment.

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“It’s going to be painful,” Goolsbee said in later to reporters. “It would necessarily be painful.”

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Goolsbee’s comments contradict Fed Chairman Kevin Warsh’s remarks last Wednesday at a news conference that took place after the Fed lifted its key interest rate for the first time in three years to about 3.9 per cent.

“I don’t believe that we need to do harm to the labor markets to achieve our objective,” Warsh said last week.

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The Fed generally fights inflation by raising interest rates to cool borrowing and spending. Historically, such rate hikes have often slowed growth and have even led to recessions.

Yet in 2022-2023, the Fed sharply raised interest rates and inflation did decline, without a significant rise in unemployment or economic slowdown.

Goolsbee also suggested while speaking with reporters that the Fed may need to implement more than just the one additional rate hike later this year that policymakers, as a group, forecast last week.

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There are signs that surging investment in data centers for AI are also pushing up inflation, he said, suggesting that strong demand is playing a role, as well as the supply shock from oil.

If inflation mostly comes from supply shocks, then just one more rate hike could be sufficient, Goolsbee told reporters.

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“And if we get evidence that convinces us that it’s coming from demand, then it likely would not be enough,” he said.