After the Federal Reserve statement removed the “supply shock” statement, Goulsby warned that demand is driving up inflation and the pace of interest rate hikes may need to be faster

The Zhitong Finance App learned that Chicago Federal Reserve Chairman Austan Goolsbee (Austan Goolsbee) said on Monday that US inflation may have surpassed the impact of tariffs and energy prices in the past 18 months, and now strong demand is also driving up prices, which may require the Federal Reserve to raise interest rates at a faster pace.

Speaking to the Official Monetary and Financial Institutions Forum (Official Monetary and Financial Institutions Forum) in London, Goulsby said that the rise in inflation over the past 18 months was initially thought to be due to tariffs, followed by an oil price shock. Central bank officials tend to “turn a blind eye” to these supply-side issues, not raise borrowing costs, and expect them to subside on their own.

But this supply-driven inflation is showing sustainability, Goulsby said. He also said that there is evidence that strong demand is now exacerbating this problem — booming investment in artificial intelligence may drive up prices in a wider range of ways, while high inflation in the service sector suggests that cost pressure is not only due to continued oil price shocks.

“If the main line is that it comes from overheated demand, I think the implication is that interest rate reactions will be more aggressive and forward-looking,” he said. In recent data and conversations with business contacts, “We increasingly feel... part of this may be due to overheated demand.”

“If demand overheats, there's no room for ambiguity about how the Fed needs to respond,” Goulsby said when talking about the possibility of higher interest rates, and pointed out that the scale of investment in artificial intelligence may “be spilling over its own racetrack and driving total output above the level the economy can absorb.”

The Federal Reserve raised policy interest rates by a quarter of a percentage point after a two-day meeting last week. At the press conference after the meeting, Federal Reserve Chairman Walsh emphasized the strong momentum in domestic consumption, corporate investment, and other aspects of the demand side of the economy.

Policymakers also removed the statement from the policy statement attributing high inflation to “supply shocks driving up prices in some industries, including energy,” and instead simply stated that “inflation is still high.”

“The Hard Way”

Goulsby said that it is still a matter of debate about how much demand and supply factors currently drive inflation, and he is open to this possibility: an improvement in supply conditions may still depress prices without further action — or even lead to interest rate cuts in the future.

But at the same time, he said that the lesson since the COVID-19 pandemic is that in theory, supply shocks should only have a temporary impact on inflation; their effects are being proven to be more lasting, so central banks may not be able to turn a blind eye to them when formulating monetary policies.

The standard idea is to ignore supply shocks and assume that they will largely correct themselves, because industry output will eventually rebound after shortages or bottlenecks occur. “Oil, tariffs and commodity prices — forecasters spent over a year repeatedly delaying the point where inflation should have peaked and fallen. ... It's not a reassuring model,” Goulsby said. “We need evidence that these shocks are actually fading, otherwise it's hard to see a credible path back to 2% inflation — even harder to find reasons to keep turning a blind eye.”

The Federal Reserve's inflation target is 2%. The personal consumption expenditure (PCE) price index, which is the Federal Reserve's main indicator of inflation, rose 3.7% year on year in July, and there has been little improvement recently.

“In such an environment, the only way back is to take the difficult path,” that is, by raising interest rates, to bear the risk that the subsequent economic slowdown poses to growth and employment. Goulsby is not a voting member of the Federal Open Market Committee (FOMC) interest rate decision-making body this year. On Monday, he did not comment on the results of last week's meeting or his own monetary policy outlook.