The Federal Reserve faces a simple challenge at its June meeting: Do not mistake an energy shock for an overheated economy.
For much of the past year, I have argued that lower interest rates would support small businesses, encourage investment, and improve economic growth.
The recent surge in energy prices has altered the near-term policy landscape. Crude oil prices have risen sharply in recent weeks as geopolitical tensions in the Middle East have increased. The question facing the Federal Reserve is no longer whether lower rates would eventually benefit the economy. The question is whether policymakers should respond to inflation driven largely by higher energy costs by tightening policy further.
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They should not.
The prudent course is to hold rates steady, allow the energy shock to work through the economy, and avoid creating new obstacles for businesses and consumers at a time when the economy continues to demonstrate resilience.
The current economy is experiencing an inflation squeeze driven largely by higher energy costs, not excessive demand. That distinction matters because it requires a different policy response. An overheated economy may require tighter monetary policy. A temporary supply-driven shock requires stability and patience.
Core inflation measures remain below headline inflation, suggesting that underlying demand conditions are more stable than overall inflation figures might imply.
Advocates of tighter monetary policy have a valid concern. The Federal Reserve spent years working to restore inflation credibility, and policymakers understandably want to avoid allowing temporary price increases to become embedded in broader inflation expectations. That risk deserves serious attention. The challenge is that today’s inflation pressures appear increasingly tied to energy markets rather than excessive consumer demand.
Employment remains relatively stable. Consumers continue to spend. Businesses remain cautious but active. Economic growth remains positive despite elevated interest rates, tariffs, and geopolitical uncertainty.
Policymakers should focus on what the data are actually saying. Oil remains one of the foundational inputs of the modern economy, affecting transportation, manufacturing, agriculture, construction, and thousands of products Americans use every day. When energy prices rise, the effects move quickly through supply chains and business operations. Energy inflation does not stay at the gas station. It spreads throughout the economy.
Consumers and businesses are not behaving as if the economy is overheating. The economy is neither entering a recession nor accelerating uncontrollably.
The Federal Reserve can influence demand through interest rates. It cannot produce oil, stabilize the Middle East, or eliminate the geopolitical risks driving higher energy costs. Monetary policy moves through the economy one business, investment decision, and hiring decision at a time. When financing becomes more expensive, expansion slows, hiring is delayed, and growth loses momentum.
Increasingly, economic slowdowns begin not with collapse, but with hesitation. Capital sits on the sidelines. Hiring plans are delayed. Investments that would expand capacity and productivity are put on hold.
Raising rates further would do little to address the source of today’s inflation while increasing pressure on businesses and consumers already navigating a more expensive operating environment.
Small businesses would feel that pressure most acutely. They account for nearly all U.S. businesses, employ almost half of private-sector workers, and remain a primary source of job creation. Unlike large corporations, they are often more dependent on bank financing and more sensitive to borrowing costs. Every increase in interest rates raises the hurdle for hiring, expansion, equipment purchases, and investment.
Housing provides a clear example. Elevated mortgage rates continue to challenge affordability and weigh on residential construction. The automotive sector faces similar pressures as financing costs affect consumers. Additional rate hikes would do little to lower energy costs while creating new headwinds for industries that support millions of jobs and significant economic activity.
The encouraging news is that many of the ingredients for stronger growth are already in place. Manufacturing investment remains significant, companies continue to reshore supply chains, and the United States continues to attract global capital. Policymakers have increasingly focused on infrastructure investment and expanding productive capacity. The data point to an economy that is cautious but resilient, facing higher costs yet continuing to expand.
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Once energy prices stabilize, the economy’s underlying strength is likely to become much more apparent. Delayed investments can move forward. Consumers can regain purchasing power. Confidence can improve. Growth can accelerate.
The Federal Reserve cannot control oil production, shipping routes, or geopolitical tensions. What it can do is avoid adding unnecessary pressure while the economy absorbs a temporary shock. Holding rates steady would preserve flexibility, support confidence, and allow businesses to continue investing, hiring, and expanding productive capacity. As the Federal Reserve approaches its June meeting, patience may prove to be the most effective policy tool available.
Dan Varroney is an economic strategist, founder and CEO of Potomac Core, and author of Rethinking Economic Growth.