Fed sticks to course – the oil price shock leaves no other choice
Lena Dräger, Research Director of the Monetary Macroeconomics Group at the Kiel Institute for the World Economy, comments on the expected decision by the US Federal Reserve to keep the federal funds rate unchanged today:
"The Fed is expected to leave the policy rate unchanged today in the range of 3.50 to 3.75 percent—and that is the right decision. The war in Iran has thrown the energy markets into a state of emergency: The closure of the Strait of Hormuz has driven the oil price above USD 100 per barrel, gasoline prices at the pump have surpassed the psychologically important USD 4 mark, and CPI inflation jumped to 3.3 percent in March. A rate cut in this environment would be unjustifiable from a monetary policy perspective—it would fuel core inflation and undermine confidence in the Fed’s commitment to price stability.
The Fed faces a classic stagflationary dilemma: The oil price shock is driving inflation higher while simultaneously dampening the real economy. Simulations by the Federal Reserve Bank of Dallas show that the shock could raise overall inflation by about 0.6 percentage points in 2026—with the risk of second-round effects on food, transportation, and freight prices, as well as inflation expectations.
Added to this is the institutional uncertainty surrounding the upcoming leadership change at the Fed. Powell must use what is likely to be his final interest rate decision as Fed Chair to send a clear signal: The Fed responds to economic data, not political pressure. Pausing the federal funds rate is therefore not only the right thing to do economically, but also institutionally necessary—to preserve institutional trust during a period of transition."
