The Fed is Misreading the Inflation Risks

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It is understandable why Federal Reserve officials decided not to let the war with Iran affect their monetary policy decision on Wednesday. The range of outcomes is so vast that it makes sense to wait until there are hard data on the responses of consumers and businesses.What is not understandable is Fed officials’ faith that—leaving the war aside—inflation will return quickly to their 2% yearly goal as the economy accelerates and interest rates continue to fall.This is a failure of analysis. According to Jerome Powell’s latest press conference, Fed officials believe that their policy has been “restrictive” (it has not), that inflation would already be at or close to 2% if not for tariffs (it would not), and that “the labor market is clearly not a source of inflationary pressures” (it is). The latest data, which run through February, make it clear that the inflation situation was continuing to get worse before the current conflict.From that perspective, Fed officials should have been following the Reserve Bank of Australia, which has pivoted to raising rates, even without the war with Iran. Including a reasonable distribution of the possible consequences of the war into the calculations reinforces the case for rate increases.Goods and BadsPerhaps the most striking thing about Powell’s Wednesday press conference was the repeated—and wrong—insistence that excessive inflation was mostly about rising goods prices, which in turn were mostly about tariffs:Inflation has eased significantly from its highs in mid-2022 but remains somewhat elevated relative to our 2 percent longer-ru…