The Federal Reserve, led by new Chairman Kevin Warsh, is facing challenges in its efforts to combat inflation. With inflation hovering at 3.5%, above the 2% target, the Fed is under pressure to act. However, its inflation-fighting tools are limited when it comes to combating the supply-driven inflation America is facing now.

Supply-Driven Inflation

The current inflation is driven by supply problems, including the war with Iran, which has derailed the flow of energy from the Middle East, lifting prices on diesel, gasoline, and jet fuel. High tariffs have also driven up the cost of some goods. The Fed’s ability to address these issues is limited, as monetary policy cannot tame supply-driven inflation without exacting unacceptable unemployment costs.

Former Fed Chair Janet Yellen argued that the default strategy for the Fed should be looking through supply shocks, instead of being tempted into rate hikes. Economists say inflation expectations, especially market-based measures, are not near the danger zone, which would require the Fed to take action.

Rate Hikes and Their Impact

Raising rates to cool demand could tip over the stock market, which could take down the shaky job market. The labor market is weak, and it wouldn’t take a lot to push us into a recession. The exception would be if inflation expectations skyrocket, which could lead to a self-fulfilling prophecy of higher prices and wages.

The Fed’s decision on interest rates is just a day away, and there is an unusual amount of drama over what officials will do. The market is pricing in a 38% chance of a hike and a 62% chance of no change. The suspense is driven in part by Warsh’s refusal to telegraph what the Fed is likely to do.

Original reporting: El Paso News (HLL/CB) — read the source article.