Central banks are facing a dilemma due to the energy crisis triggered by the Middle East conflict: whether to raise interest rates to combat inflation at the risk of harming growth, or to wait and potentially miss the optimal timing.

In an interview on Thursday, Chicago Federal Reserve Bank President Austan Goolsbee warned that persistent energy shocks and stubborn inflation could push the U.S. economy toward "stagflation," characterized by simultaneous increases in unemployment and prices.

The following is an edited excerpt from the interview:

Q: To what extent has the Middle East conflict altered your view on inflation?

A: "It has clearly significantly increased short-term overall inflation. That said, U.S. inflation was already high, and the momentum for improvement has stalled. I believe the decline in tariff-driven goods inflation has been far slower than expected. Looking at U.S. services inflation, it remains elevated and is still climbing—this cannot be attributed to tariffs or oil. Therefore, even setting aside the war, there are concerning aspects."

"At the Fed's last meeting of the previous year, I voted against the decision to cut rates... I do not regret dissenting, as inflation has proven more persistent than projected at that time."

Q: How concerned are you about stagflation?

A: "I am concerned about the economy moving toward stagflation—meaning both inflation and unemployment rise simultaneously. This is entirely possible and represents the worst-case scenario. It is one of the most challenging situations a central bank can face, as neither raising, cutting, nor holding interest rates can resolve it."

"The more stagflation shocks we encounter, the more we, as a central bank, are placed in this predicament, forced to choose between two undesirable outcomes: an economic downturn or triggering more severe inflation and causing inflation expectations to become unanchored."

Q: If you had to vote now, what kind of interest rate decision would you support?

A: "The U.S. labor market has remained relatively stable over the past 18 months. Hiring activity is limited, but layoffs are also low. I believe the threat to the Fed's employment mandate is not as urgent as the inflation threat. Our inflation rate has been above target for five consecutive years. We have stalled in this regard, and the situation is now moving in the wrong direction. For me, the inflation danger is the more immediate threat at present."

Q: What lessons can be drawn from the Fed's recent tightening cycle?

A: "Supply shocks have distinct and significant impacts on the central bank's typical trade-offs, with both positive and negative aspects. On the negative side, the pandemic severely disrupted supply chains, leading to higher inflation than anticipated. Then, as supply chains repaired, inflation receded without triggering a recession, which is historically unprecedented."

"If this war continues, for Japan, a major net energy importer, it would be purely a negative supply shock. Formulating monetary policy would then become extremely challenging. However, if the war ends and supply chains are restored, Japan might benefit from the dynamics the U.S. experienced, where inflation declined without monetary policy needing to counteract fiscal policy."

Q: What are manufacturers in your district saying about the fuel crisis?

A: "Automakers indicate that the duration of this situation is critical. They say that if prices fall as futures markets suggest, it would be manageable. They have some inventory of components. But if this persists for months, given their just-in-time production model, almost all their parts and supplies are in transit at any given moment—either on ships or trucks. They will begin to encounter a series of supply chain difficulties. I don't think this has truly happened yet, but they are approaching a scenario of supply chain disruption."

Q: How will the internal dynamics at the Fed change under the leadership of new Chair Kevin Warsh?

A: "When he served as a governor at the Fed, I was Chair of the Council of Economic Advisers in the Obama administration, and we met monthly. I worked with him during a highly stressful period; he is level-headed and quite reasonable."

Q: Despite political pressure from U.S. President Trump, do you believe he would raise interest rates if necessary?

A: "I don't know what he is thinking, but based on my past observations of him, he is a very rigorous person. I think that would be a good thing."