By Howard Schneider
WASHINGTON, Sept 21 (Reuters) - US inflation may have moved beyond the tariff and energy prices shocks of the last 18 months and is now being driven by strong demand as well, potentially requiring a faster pace of Federal Reserve interest rate hikes, Chicago Fed President Austan Goolsbee said on Monday.
Rising inflation over the past 18 months had been seen as stemming initially from tariffs and then oil price shocks, with central bankers inclined to "look through" those supply-side
problems without raising borrowing costs on the expectation that they would fade on their own, Goolsbee said in remarks to the Official Monetary and Financial Institutions Forum in London and later to reporters.
But the supply-driven inflation is proving persistent, said Goolsbee, who added that there is evidence that strong demand is now adding to the problem, with booming investment in artificial intelligence potentially driving prices higher on a broader basis, and high services-sector inflation suggesting cost pressures are not just about the ongoing oil price shock.
"If the through line is that it's coming from overheating demand, I think the implication is the rate response is more aggressive and more and more front-loaded," he said. In recent data and in conversations with business contacts "we've been getting a little more sense ... that some of it maybe is coming from overheating demand."
"If demand overheats, there is no ambiguity about how the Fed needs to respond," Goolsbee said of the possible need for higher interest rates, noting that the level of investment in artificial intelligence could be "spilling out of its own lane and raising aggregate output beyond what the economy can absorb."
The Fed raised its policy rate by a quarter of a percentage point last week after the end of a two-day meeting. In a post-meeting press conference, Fed Chairman Kevin Warsh emphasized the strength of domestic spending, business investment, and other aspects of the demand side of the economy.
Policymakers also dropped language from their policy statement attributing elevated inflation to "supply shocks that have driven price increases in certain sectors, including energy," and saying simply that "inflation remains elevated."
'THE HARD WAY'
Goolsbee said the mix of demand and supply issues currently driving inflation remains a matter of debate, and that he is open to the possibility that improving supply conditions could still lower price pressures without further Fed action — or even lead to lower rates in the future.
But he also said the lesson since the COVID-19 pandemic is that supply shocks that in theory should have only a temporary impact on inflation are proving to have a more persistent influence, and as a result cannot necessarily be ignored by the central bank in setting monetary policy.
While standard thinking is to ignore supply shocks as largely self-correcting, as industry output inevitably bounces back after shortages or bottlenecks develop, "oil, tariffs, and commodity prices — forecasters have spent more than a year pushing back the date when inflation was supposed to peak and start falling. ... That's not a comforting pattern," Goolsbee said. "We need evidence that these shocks are actually fading, or it's hard to see a credible path back to 2% inflation — and harder still to justify continuing to look through them."
The Fed has a 2% inflation target. The Personal Consumption Expenditures Price Index, the Fed's main gauge of inflation, was 3.7% in July on a year-over-year basis, and has shown little recent improvement.
"In environments like that, the only way back is the hard way," namely with higher interest rates and the risks that poses to growth and jobs as the economy slows, said Goolsbee, who is not a voting member of the central bank's rate-setting Federal Open Market Committee this year. On Monday, he did not comment on the outcome of last week's meeting or his monetary policy outlook.
(Reporting by Howard Schneider; Editing by Nick Zieminski and Paul Simao)
