Former Federal Reserve Senior Official: In the Face of the Iran Energy Shock, All the Fed Can Do Is “Wait and See”

The Federal Reserve is facing new challenges under mounting pressures. Beyond the tariff turmoil, uncertainties around artificial intelligence, and threats to its independence, the energy supply shock triggered by the Iran war has become the latest dilemma for monetary policymakers.

Former New York Fed President and Bloomberg columnist Bill Dudley believes that before the scale and duration of the shock become clear, the Federal Reserve will choose to wait and see.

In an article published Thursday, Dudley wrote that oil prices have now soared well above $100 per barrel, and in the coming months, the year-over-year inflation rate measured by the Personal Consumption Expenditures Price Index could approach 4%. Meanwhile, strong nonfarm payroll growth in March shows the economy remains resilient, partially offsetting the short-term drag from rising energy prices.

Against this backdrop, the Fed’s room for policy maneuver is constrained by multiple factors. Any move to cut rates could provoke doubts about its policy motives, especially as the Trump administration continues to pressure the central bank’s independence and with Trump’s nominee, Kevin Warsh, set to take over as chairman.

High Uncertainty in the Scale and Duration of the Supply Shock

According to Dudley, the full picture of this energy shock has yet to emerge.

Currently, oil and gas shortages are mostly concentrated in the maritime shipping sector—ships that should be heading to Europe and Asia are stuck in the Persian Gulf. If the Strait of Hormuz remains blocked, shortages will gradually spread to on-land terminals of import-reliant countries. Even if the Strait reopens, it will take several weeks for the region to replenish depleted inventories.

The current fragile ceasefire makes the outlook even more unpredictable. The ultimate scale and duration of the shock will directly determine whether, and how, the Federal Reserve will need to act.

Dual Pressures from Inflation and Growth Create Policy Dilemmas

The economic impact of rising energy prices is twofold.

On one hand, higher energy costs will suppress real income and curb consumption, hitting low-income households without financial buffers the hardest; on the other hand, rising energy prices will directly lift overall price levels.

With inflation having exceeded the Fed’s 2% target for five consecutive years, this shock makes policymaking even more challenging. Though the Fed has traditionally tended to "look through" temporary price shocks, this approach is under greater stress in the current environment.

Currently, long-term market inflation expectations remain relatively stable—those implied by Treasury Inflation-Protected Securities (TIPS) for the next five to ten years have held slightly above 2% since the outbreak of the war, and household survey data likewise remains steady. However, analysts point out that it may be too soon to determine if there has been a substantive shift in expectations.

Economic Resilience Provides a Buffer, but Recession Risks Cannot Be Ignored

The U.S. economy still has some support at present.

Strong March employment data, combined with higher tax refunds from last year’s “American Rescue Plan” cut to overtime pay, tips, and Social Security taxes, could help offset the short-term negative impact of rising energy prices. Some households even enjoyed overtime tax breaks that went beyond the original legislative intent, so the real boosting effect may exceed expectations.

However, long-term risks should not be underestimated. Research by University of California, San Diego, economist Jim Hamilton shows that energy shocks have always been a key trigger for economic recessions. The current labor market has cooled, with both hiring and layoffs at low levels.

If this energy shock leads to a sustained drag on consumer spending, and the scale and duration are sufficiently large, it is not impossible for the economy to ultimately slip into recession—even though AI investment, fiscal stimulus, and relatively loose financial conditions remain important counterbalancing forces.

Fed’s Independence Pressures Make Policy Actions Even More Complicated

On the monetary policy front, the Federal Reserve is facing not just economic dilemmas, but also additional political constraints. Continued attacks on the Fed’s independence by the Trump administration mean any rate cut could be interpreted as a concession to political pressure, thereby undermining market confidence in the Fed’s anti-inflation resolve.

With Kevin Warsh expected to take over as chairman, the market’s judgment about the Fed’s future policy direction is becoming even more complex. Dudley believes the Federal Reserve must be extremely cautious to ensure its actions do not disrupt inflation expectations. For now, since the severity and duration of the shock, as well as its impact on inflation expectations and the job market, remain unclear, waiting and observing is the safest option. If the risks tilt clearly toward one side of the dual mandate—either price stability or full employment—it will not be too late to act then.