Federal Reserve Chair Jerome Powell, speaking at a moderated conversation at Harvard University, explained how the ongoing US-Israeli war involving Iran is shaping the central bank’s thinking. Though the geopolitical shocks like rising oil prices typically do not trigger immediate action, Powell stressed that this moment is different because inflation has already been elevated in recent years. Here are the key 10 takeaways from the discussion:
Inflation expectations are at the core of decision-making
Powell repeatedly emphasised that the Fed’s response will depend less on immediate price spikes and more on how people expect inflation to behave going forward.
“The tendency is to look through any kind of a supply shock,” he said, referring to events like oil price spikes. However, he added that “a critical, essential aspect of that is you have to carefully monitor inflation expectations.”
Short-term shocks may not justify immediate policy action
Powell pointed out that monetary policy does not work instantly, which makes reacting to temporary shocks tricky. “Monetary policy works with long and variable lags,” he said, noting that “by the time the effects of a tightening… take effect, the oil price shock is probably long gone.” This explains why central banks often avoid reacting aggressively to short-lived disruptions, even if they push prices higher in the near term.
Fed faces a sharp trade-off between inflation and jobs
A central theme of Powell’s conversation was the growing tension between the Fed’s dual mandate. “There’s sort of downside risk to the labour market, which suggests keep rates low,” he said.
“But there’s upside risk to inflation, which suggests maybe don’t keep rates low.” This puts the Fed in a difficult position, where acting to fix one problem could worsen the other, especially as the war impacts both prices and growth.
Policymakers are choosing to wait and watch
Regardless of the uncertainty, Powell hinted that the Fed is not rushing into any immediate policy shift. “We feel like our policy’s in a good place for us to wait and see how that turns out,” he said.
The path of interest rates has become less predictable
Just days ago, the Fed’s projections pointed to a rate cut this year. Now, market expectations are shifting in the opposite direction as inflation risks rise. Powell acknowledged that the balance of risks could push rates “lower or higher,” depending on how the situation evolves.
Fed remains committed to its 2% inflation target
Even as new risks emerge, Powell reaffirmed the central bank’s long-term goal. “We will get inflation back to 2%… we are committed to getting it there on a sustained basis,” he said. This commitment is crucial for maintaining credibility, especially at a time when external shocks are testing the Fed’s resolve.
Inflation expectations are stable, but being closely watched
For now, Powell said there are no signs of a major shift in long-term expectations. “Inflation expectations do appear to be well anchored beyond the short term,” he said. However, he cautioned that the Fed is not complacent and will remain alert to any changes. This also tell us that while the situation is under control for now, it could become a concern if conditions worsen.
Repeated supply shocks could change behaviour
Powell warned that the real danger lies not in a single shock, but in repeated disruptions. “You can have a series of these supply shocks… [that] lead the public… to start expecting higher inflation over time. Why wouldn’t they?” he said. Such a shift in mindset could make inflation more persistent and force the Fed to respond more aggressively.
Internal disagreements within Fed
Addressing recent dissent within the Fed, Powell said differing views are natural in such uncertain times. “To try to expect unanimity… it would almost be misleading,” he said, adding that he welcomes “robust debate.”
Financial stress is emerging
Powell also pointed to risks in private credit markets, including rising defaults and investor pullbacks. “I’m reluctant to say anything that suggests that we’re dismissive of the risk,” he said, but added, “we don’t see… the makings of a broader systemic event.”
Powell’s remarks come shortly after the Federal Reserve decided to keep its benchmark interest rate unchanged in the 3.5% to 3.75% range following its latest policy meeting. Once again Powell has made it clear that Fed’s stance could shift if inflation expectations begin to rise or if the economic impact of the conflict becomes more pronounced.