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In this week’s Grumpy Economist Weekly Rant, John Cochrane examines the next major inflation challenge facing the Federal Reserve. With Kevin Warsh newly appointed Fed Chair, Cochrane argues that the central question is no longer simply whether the Fed should lower interest rates, but how it should respond to competing forces: productivity gains from artificial intelligence, tariffs, oil price shocks, and renewed inflation pressure.
Cochrane raises a deeper question about how the Fed should respond when prices move for very different reasons—from productivity gains that make goods cheaper to tariffs and oil shocks that push prices higher. As affordability concerns intensify, he asks whether the Fed should continue to “look through” temporary price-level shocks—or reconsider how those shocks affect expectations, households, and the credibility of monetary policy.
Read more on this topic:
“How to protect the economy from the ghosts of 1979”, The Washington Post, May 20, 2026
“Does History Rhyme?”, The Grumpy Economist, February 2026
Transcript
Hi, I’m John Cochrane, senior fellow here at the Hoover Institution, and welcome to my Grumpy Economist Weekly Rant.
Today, we’re going to think about the Federal Reserve. Our colleague and my friend, Kevin Warsh, has just been appointed Fed chair, and that gives us the time to think about what challenges he and the Fed will face going forward.
First of all is, of course, what to do with interest rates. Last summer, when President Trump was making his decisions, the big question was: Should the Fed lower interest rates, and how quickly? Most people at the Fed had forecasts that said inflation would continue to go down to 2%, so they were in favor of slowly easing interest rates.
Another argument went that artificial intelligence would soon raise productivity and make things a lot cheaper. That’s true. If artificial intelligence comes along and there’s a big surge of productivity, wages are going to be higher than the prices of goods and services. It makes everything cheaper.
So should the Fed fight that deflation in the price of goods and services by lowering interest rates? In other words, raising the level of everything, raising wages so prices could stay the same, rather than letting prices go down. That’s a debatable point, actually.
What’s wrong with prices going down if wages are up? A supply deflation is different from, oh, the Great Depression, when there was a demand deflation, and wages went down along with prices.
After all, we’re in an affordability crisis, aren’t we? Wouldn’t a lot of Americans be happy if the price of everything went down?
Also, AI needs a lot of savings and investment. So real interest rates have to go up in order to spur the savings to invest in the data centers. That’s an interesting argument, but that’s so last year because, of course, now we face tariffs, oil price shocks, and inflation is surging again.
It looks a lot like 1979, which is not a pleasant thought.
So now the big question before the Fed is, with tariffs and oil price shock and inflation rising, should it swiftly raise interest rates, or should it look through—that’s another one of these fun Fed phrases—the increase in inflation?
After all, tariffs and oil prices are a one-time rise in the price level. You get inflation while the prices are going up, but then it stops.
We had a one-time rise in the price level in 2021 and 2022, a surge of inflation that went away. Is everyone really happy with that?
So that, too, is a contentious question. Yes, that kind of one-time price-level shock, the inflation will go away, but prices will go up, and people will be awfully unhappy. Also, inflation that’s a one-time rise can get embedded in people’s expectations and keep going.
That’s a tough question, and that’s one that we’ll be talking about for a long time. I think, actually, the thinking is changing on this issue.
Maybe the Fed should not always seek to stabilize inflation and ignore one-time price-level rises. Maybe the fact that everybody’s angry about affordability says that the Fed should fight that sort of thing. If prices have to go up for a while, bring them back down again.
As I said, it’s a time for a big thought about how the Federal Reserve should act.
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John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. An economist specializing in financial economics and macroeconomics, he is the author of The Fiscal Theory of the Price Level. He also authors a popular Substack called The Grumpy Economist.