This is why the Fed can afford to look through the Iran War energy shock

The vacancy-to-unemployed ratio currently stands at 0.91 — meaning there are fewer open jobs than unemployed workers. At the peak of post-COVID labor market tightness, that ratio exceeded 2. This structural difference is the strongest argument the Fed has for looking through the Iran War energy shock.

The Federal Reserve and other central banks are facing the same decision: whether to “look through” the cost of living implication of the energy crisis resulting from the Iran War. Fed Chairman Jerome Powell on Monday said the US central bank can still afford a wait-and-see approach to this decision: “We’re getting now an energy shock: no one knows how big it will be. It’s way too early to know.”

The “look through” strategy — holding rates steady through a supply-driven price spike — is textbook central bank response. As monetary policy works with a “long and variable lag,” the effect of those interest rate increases may not arrive early enough to help put a lid on the short-lived inflation surge, but only risks inflicting damage on the real economy well after the price pressure has already faded.

The precondition for “looking through” is that the public’s inflation expectations stay anchored. This is the lesson macroeconomists learned from the 1970s stagflation: once households and firms expect elevated inflation to persist, they adjust their behavior — workers demand higher wages, retailers raise prices more frequently to offset rising costs. 

The COVID Experience

While central bankers maintained that long-term inflation expectations were well anchored during the pandemic period, the US arguably experienced a short spell of wage-price spiral in 2021 and 2022.

Consumer demand for goods and services was strong while the labor market was tight; the COVID- and Ukraine war-induced supply disruption bled into a genuine wage-price dynamic in 2021–22, forcing the Fed into one of its sharpest tightening cycles in decades.

Those conditions don’t exist today.

Labor market is too weak for wage-price spiral

The current 0.91 vacancy-to-unemployment ratio means there is less than one job opening for every unemployed worker in the US. 

The New York Fed’s Labor Market Tightness Index — a weighted measure of quits and vacancies relative to effective job seekers — currently sits at -0.26, down from a peak of 2.89 in March 2022. Below zero, the index signals wage growth running below its historical average. There is no obvious transmission channel for a wage-price spiral.

This should give the Fed a strong reason to hold off on a rate hike in the near future.