Federal Reserve’s Stance on Energy Shocks Amid Iran Conflict

Jerome Powell, the Chairman of the Federal Reserve, expressed on Monday that the central bank aims to navigate the current situation arising from the Iran conflict without triggering an energy shock. He noted that historical supply disruptions are typically short-lived, and despite the war, long-term inflation expectations seem stable.

Speaking to economics students at Harvard University, Powell explained that the usual response from central banks during energy shocks is to adopt a wait-and-see approach rather than making immediate policy changes. Although oil prices have surged since the onset of violence, public expectations for inflation over the long term appear to be “firmly anchored beyond the short term.”

However, Powell also acknowledged that the Fed cannot take this stability for granted. He pointed out that inflation has consistently stayed above the central bank’s target of 2% even years after the pandemic, and that ongoing price shocks could potentially alter public perception.

“These supply shocks could occur in sequence, which might lead businesses and households to anticipate higher inflation over time,” Powell remarked. “Why not?”

The Chairman described the Fed’s current situation as a balancing act between maintaining price stability and promoting maximum employment.

“There are risks that suggest we should keep rates low for the labor market, but there are also inflation risks that may indicate we shouldn’t keep rates low,” he said.

Since the military actions taken by the United States and Israel against Iran about a month ago, oil prices have surged, affecting shipping routes through the Strait of Hormuz and posing threats to global supply chains. Notably, the Fed’s preferred measure of underlying inflation was already rising prior to the conflict.

Powell refrained from detailing how the Fed might reconcile its responsibilities if it had to make a choice. “Ultimately, we may be faced with the question of what to do here,” he said, acknowledging the uncertainty regarding the economic impact of the ongoing situation.

These remarks come during a challenging time for the central bank. The Federal Reserve decided to keep interest rates unchanged during its March 18 meeting, voting 11-1 in favor of maintaining the federal funds rate within a range of 3.5% to 3.75%. Only Fed Director Stephen Milan opposed this decision, advocating for rate cuts.

Powell’s term as chairman is set to expire on May 15th. At present, the Senate has yet to schedule a confirmation hearing for Kevin Warsh, who has been nominated by President Trump to succeed Powell. Senator Thom Tillis, a Republican from North Carolina, has indicated he will block Warsh’s confirmation until the Justice Department concludes its investigation into Powell. Earlier this month, Powell suggested, without evidence, that he might remain as “interim chair” if a successor is not confirmed by the end of his term. Typically, a chair doesn’t continue beyond their term without being reappointed or asked to stay until a new chair is designated.

In the period since the March meeting, Fed officials have conveyed that the threshold for cutting interest rates has significantly increased. Several policymakers have suggested that the central bank will likely maintain interest rates unless there are clear signs of labor market deterioration or inflation approaches the 2% target.