Central banks of various countries can't control wars; experts warn: raising interest rates neither produces oil nor opens shipping routes.

Whenever turmoil in the Middle East pushes up oil prices, concerns about central banks raising interest rates follow closely behind.

However, recently economist Alexander Salter issued a warning in an analytical article published at TheDailyEconomy.org: When inflation’s root cause lies in geopolitical conflicts and supply disruptions, monetary policy is fundamentally powerless, and aggressive tightening not only cannot solve energy shortages, but could also turn an external supply shock into a domestic demand recession, exacerbating the economic downturn.

Salter points out that whether it’s the interest rate decisions of the US, Europe, or the UK, they cannot produce one more barrel of oil from the Persian Gulf, nor can they reopen blocked trade routes. Faced with supply-driven inflation, the real role of central banks is to prevent panic in financial markets from spreading to the credit market, and to avoid the economy slipping into a self-reinforcing downward spiral—not trying to “defeat” a war by suppressing demand.

This judgment has direct implications for investors. If central banks misjudge the situation and aggressively raise rates during a supply shock, the market will face a double blow: not only bearing the cost pressure from rising energy prices, but also confronting employment declines and shrinking investment brought on by monetary tightening. Salter warns, the worst outcome of policy error is—before the war-driven inflationary pressure has faded on its own, the central bank plunges the economy into deeper recession.

Supply Shocks and Demand Shocks Have Different Natures—The Same Policy Tool Cannot Be Applied

Salter’s argument begins with the classic macroeconomic framework distinguishing “demand-driven inflation” from “supply-driven inflation.”

When inflation is caused by overheated demand—that is, too much money chasing too few goods—central bank intervention is justified, and tightening policy can cool overheated consumption and investment without causing long-term economic harm.

But the oil shock triggered by war is of a completely different nature. Tighter energy supply or soaring transport costs mean the entire economy becomes poorer and less productive. This is a real loss that an economy must absorb after undergoing an external blow, and not an illusion that monetary policy can resolve. Salter argues that trying to fully offset this reality with monetary tightening may actually create worse outcomes: further adding falling output and rising unemployment on top of already high prices.

The Cost of Aggressive Rate Hikes: Unemployment Is Harder to Bear Than Inflation

Salter acknowledges the pain caused by war-driven higher energy prices is unavoidable—households will pay more at the gas pump, and companies will face higher costs. However, he believes aggressive tightening by central banks would turn this external shock into a collapse of domestic demand, with potentially even more serious consequences.

His judgment is clear and direct: For the vast majority of workers, keeping their job in a 4% inflation environment is far more acceptable than losing their job in a 2% inflation environment.

Slowing money growth and raising rate targets cannot solve the fundamental supply shortage; they only redistribute the burden—often transferring it onto workers. In this scenario, rate hikes essentially trade job losses for a reduction in an inflation figure that central banks are powerless to eliminate, making the cure worse than the disease.

The Proper Role of Central Banks: Focus on the Demand Side, Prevent Second-Order Effects

Since “defeating” supply shocks isn’t possible, what should central banks do? Salter offers a clear functional positioning.

During geopolitical crisis, monetary authorities’ most effective stage is in stabilizing the demand side. Specifically, when financial stress indicators signal danger, central banks can provide liquidity to markets to prevent financial stress from amplifying shocks; can assure markets the banking system and capital markets will continue to operate normally; and can use routine open market operations to prevent a widespread collapse in investment and employment.

Salter stresses that the true danger isn’t the first wave of rising energy prices, but frightened investors, tighter credit conditions, or collapsing market confidence triggering a self-reinforcing economic downturn. The central bank’s task is to prevent these “second-order effects,” rather than confronting the “first-order shock” it cannot change.

Credibility Comes From Accurate Judgment, Not Mechanical Responses to Every Price Hike

Salter anticipates critics’ doubts: Doesn’t tolerating temporarily high inflation risk unanchoring inflation expectations and damaging central bank credibility?

His response is, credibility is not built by mechanically responding to every price increase, but by accurately identifying the source of inflation and responding appropriately. If the public understands that central banks can distinguish supply shocks from demand shocks, credibility is actually preserved.

Salter believes that, provided inflation expectations remain anchored, the optimal strategy is often to “ride out” the initial inflation impulse—that is, tolerate temporarily higher overall inflation, while communicating clearly to emphasize the external and temporary nature of the shock. He states bluntly that central bank officials should tell the public directly: price surges are the result of geopolitical events and are beyond monetary policy control—the Federal Reserve cannot drill for oil, nor can it end wars.

The worst policy mistake, Salter concludes, is acting hastily out of impatience: aggressively tightening before the war-driven inflationary pressure begins to fade on its own, thereby deepening the economic downturn and turning avoidable losses into reality. War makes society poorer—this is an unavoidable fact; the best monetary policy can do is not allow the cost of economic adjustment to be higher than necessary.

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