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Federal Reserve Chair Jerome Powell recently indicated that the period of stable inflation experienced in the years leading up to the COVID-19 pandemic may be over. Speaking at a conference on May 15, 2025, he suggested that the U.S. economy might be entering an era characterized by more frequent and potentially persistent supply shocks.
Here’s a breakdown of the key points:
* Increased Supply Shocks: Powell warned of a potential increase in supply disruptions, which could stem from various factors such as geopolitical events, trade tensions (like the recently discussed tariffs), and other global economic shifts.
* Challenge for Central Banks: He noted that more frequent and persistent supply shocks would pose a “difficult challenge for the economy and for central banks” in their efforts to maintain price stability.
* Rethinking Policy Framework: Powell mentioned that the Fed is in the process of reviewing its policy framework, which was last updated in 2020, acknowledging that the economic landscape has changed considerably since then.
* Higher Real Rates: He pointed out that longer-term interest rates are now significantly higher, primarily driven by increased real rates (interest rates adjusted for inflation) rather than just changes in inflation expectations.
* Inflation Volatility: Powell cautioned that these higher real rates could lead to greater inflation volatility compared to the period between the 2008 financial crisis and the 2020 pandemic.
* Commitment to 2% Inflation Target: Despite the changing environment, Powell reaffirmed the Federal Reserve’s strong commitment to its 2% inflation target. He emphasized the importance of well-anchored inflation expectations for sustained economic expansions.
* Current Interest Rates: The Federal Reserve’s benchmark interest rate currently sits in the range of 4.25% to 4.5%. The Fed decided to hold rates steady at its meeting in mid-May 2025.
General Information about Inflation:
Inflation is the rate at which the general level of prices for goods and services is rising, and consequently, the purchasing power of currency is falling.
Common Causes of Inflation:
* Demand-Pull Inflation: Occurs when there is an increase in aggregate demand in the economy that cannot be met by the existing supply. This can happen due to factors like increased consumer spending, government spending, or export demand. With more money chasing the same amount of goods and services, prices tend to rise.
* Cost-Push Inflation: Happens when the costs of production for businesses increase. This could be due to rising wages, higher prices for raw materials (like oil), or supply chain disruptions. Businesses may pass these higher costs on to consumers in the form of increased prices.
* Built-in Inflation: This is often related to the “wage-price spiral.” If workers expect higher inflation in the future, they may demand higher wages to maintain their real purchasing power. If businesses grant these wage increases, they may then raise prices to cover the higher labor costs, leading to a self-perpetuating cycle of rising wages and prices.
* Expansion of the Money Supply: If the amount of money in circulation grows faster than the real output of the economy, it can lead to inflation. With more money available, consumers have more to spend, increasing demand and potentially pushing prices higher.
The Federal Reserve’s Role in Managing Inflation:
The Federal Reserve (also known as the Fed), the central bank of the United States, has a dual mandate: to promote maximum employment and stable prices. The Fed primarily uses monetary policy tools to manage inflation, with its main tool being the setting of the federal funds rate, which influences other interest rates in the economy.
* Raising Interest Rates: When inflation is high, the Fed may raise the federal funds rate. This makes borrowing more expensive for businesses and consumers, which can cool down economic activity, reduce demand, and help to bring inflation under control.
* Lowering Interest Rates: When the economy is weak or inflation is too low, the Fed may lower interest rates to encourage borrowing and spending, thereby stimulating economic activity and potentially increasing inflation.
* Other Tools: The Fed also uses other tools like reserve requirements (the fraction of a bank’s deposits that they must hold in reserve) and open market operations (buying or selling U.S. government securities) to influence the money supply and credit conditions.
The Federal Reserve aims for a long-run inflation rate of 2%, as measured by the annual change in the Personal Consumption Expenditures (PCE) price index. They believe this level is consistent with price stability and helps to anchor inflation expectations. Anchored expectations are crucial because if people and businesses expect inflation to remain low and stable, it influences their behavior in wage and price setting, contributing to actual low and stable inflation.

Video courtesy of Eurex

Video courtesy of Eurex