At the Federal Reserve meeting next weekKevin Warsh needs to forcefully challenge the deadly consensus that recent economic data precludes any chance of a rate cut this year.
When 2026 began, market and economic observers expected the Federal Reserve to make several rate cuts. Now the widely held belief is just the opposite: the Fed must be prepared to raise the cost of borrowing money to contain rising prices.
Why the drastic change in sentiment? The stock response is that the new economic data has fundamentally changed the situation. The recent jobs report was much stronger than expected. Business profits are strong. The huge boom in AI-related investment is putting real pressure on the cost of raw materials and electricity. Tariffs are starting to affect costs for businesses which, increasingly, will be passed on to customers. Consumers haven’t slowed their spending spree. And of course, the longer-than-expected war in Iran has negatively impacted energy and fertilizer costs by disrupting oil availability. This is affecting economies around the world. Moreover, the recovery from the damage already done to the oil infrastructure in the Middle East will not be as fast as initially expected. All of which, experts tell us, not only rules out a rate cut, but could also mean a hike—perhaps several times—in the coming months.
The facts don’t lie, but the conclusion drawn from them is deeply wrong. Raising interest rates will cause enormous and unnecessary damage. Higher mortgage rates, for example, will obviously hurt home sales, already an economic and political sore point.
The idea of trying to fight inflation by slowing economic activity is absurd. The Fed, the economics profession, and the rest of the financial and business world are victims of a profound misunderstanding about inflation. They do not make the crucial distinction between the effect of monetary inflation and non-monetary inflation. What we are experiencing now is a result of cost-increasing events. The definition of monetary inflation is the decrease in the value of a currency. Disturbances from war are not cured by depressed economic activity. are treated by treating the causes of these disorders.
You’d never know it from the current gnashing of teeth, but the dollar has recently shown strength. The price of gold, the best barometer of monetary disarray, has fallen from its highs earlier this year by more than 25% against the dollar. The dollar fared better against other currencies such as the euro and the yen.
Under normal circumstances, when currencies are stable in value, market prices fluctuate due to supply and demand. This is what we are seeing with the explosion of artificial intelligence. We may well see this boom come crashing down, but that’s normal in a free market. The resulting collapse in prices would not be deflation. Many years ago, when the auto industry was just starting out, the US saw the creation—and collapse—of several hundred automakers before a few successful, long-term players emerged.
The idea that prosperity causes monetary inflation is not entirely supported by real-world experiences. Still, the idea is holy writ at the Fed and in the minds of most policymakers. In next week’s meeting, Kevin Warsh must vigorously attack this misconception, the Phillips curve. The curve argues that there is a trade-off between unemployment and inflation. Trying to stimulate or suppress the economy based on this is ridiculous. The happy truth is that if the Phillips curve superstition stops and the focus becomes keeping the dollar stable, there is plenty of room for short-term interest rates to decline.
In the meantime, what should policymakers do? The biggest, best, and most decisive move by far would be for President Trump—with Israel—to resume the all-out assault on the evil regime in Iran. The war would have ended weeks ago had the US not prematurely halted military operations in April. Any deal with the Iranian thugs will not be worth the paper it is written on.
