US Gas Prices Are Up Nearly a Dollar a Year On, and the Fed Says the Target Waits for the War
A Federal Reserve official said on Sunday that the two percent inflation target may remain out of reach until the war with Iran ends. American drivers are currently paying close to a dollar a gallon more than they were a year ago. Crude finished last week on its second straight weekly gain, pushed by threats of strikes against Oman, a stated lack of urgency about ending the conflict, and fresh violence in Lebanon.
There is a textbook answer to this, and the textbook answer has stopped applying.
The doctrine says a central bank looks through energy shocks. The price spike is a relative price change, not a monetary phenomenon, it reverses when supply normalizes, and tightening into it destroys demand for no gain. Every first-year macro course teaches this and it is basically correct for a shock that lasts a quarter.
The shock is now in its sixth month. The strait it runs through is operating at a fifth of normal volume by choice rather than by damage, which means normalization is a political decision in Tehran rather than a logistical one. Looking through a shock requires believing it will pass. Nobody currently has grounds for that belief, and the Fed official’s remark is essentially an admission that the committee has stopped pretending otherwise.
Once an energy shock persists long enough to move expectations, it stops being relative and starts being general. Wage negotiations incorporate it. Freight contracts reprice around it. Airlines hedge into it. At that point the central bank faces the choice it spent the whole episode trying to avoid, and the July meeting minutes show the committee circling it: many participants said tightening would likely be needed if inflation did not decline, some said conditions may not be restrictive enough already.
The awkward part is what a hike would actually do. Raising the policy rate does not put tankers through Hormuz. It suppresses domestic demand to offset an imported price, which is a real tool with real costs and no mechanism to fix the underlying cause.
Which leaves an unstated dependency at the center of American monetary policy: the path of the funds rate now runs partly through a diplomatic process being mediated by Oman. That is a strange sentence to write about the world’s reserve currency. It is also, on the evidence of Sunday’s remark, roughly what the Fed thinks.