Central banks can't control wars, experts warn: interest rate hikes won't produce oil or open shipping lanes

Whenever turmoil in the Middle East pushes oil prices higher, market concerns about central bank rate hikes follow closely behind.

However, recently economist Alexander Salter issued a warning in an analysis article on TheDailyEconomy.org: when the root cause of inflation lies in geopolitical conflicts and supply disruptions, monetary policy is essentially powerless, and aggressive tightening not only fails to address energy shortages but may turn an external supply shock into a domestic demand recession, worsening the economy.

Salter points out that whether it’s the US, Europe, or the UK, rate decisions cannot increase oil production from the Persian Gulf or reopen blocked trade routes. In the face of supply-driven inflation, the real role of central banks is to prevent financial market panic from spreading to credit markets and avoid an economy falling into a self-reinforcing downward spiral—not to try to “beat” a war by suppressing demand.

This judgment has direct implications for investors. If central banks misjudge the situation during supply shocks and aggressively raise rates, markets will face a double blow: bearing the cost pressures from rising energy prices and coping with employment declines and investment contraction caused by monetary tightening. Salter warns that the worst outcome of policy mistakes is—before war-driven inflation pressures subside on their own—the central bank pushes the economy into a deeper recession.

Supply shocks and demand shocks are fundamentally different, and the same policy tools cannot be used interchangeably

Salter’s argument starts from the classic macroeconomic framework that distinguishes “demand-driven inflation” from “supply-driven inflation.”

When inflation stems from overheated demand—too much money chasing too few goods—central bank intervention is justified; tightening policies can cool overheated consumption and investment without causing long-term economic damage.

But the nature of the oil shock caused by war is entirely different. Tightening energy supplies or soaring transportation costs mean the economy becomes poorer and less productive. This is a real loss that an economy must absorb after external shocks, not an illusion that monetary policy can eliminate. Salter believes that attempting to fully hedge this reality through monetary tightening may produce worse results: adding output decline and rising unemployment on top of already high prices.

The cost of aggressive rate hikes: unemployment is harder to bear than inflation

Salter admits that the pain caused by war-driven energy price increases is unavoidable—families will pay more at the pump, and businesses will face higher costs. However, he believes that aggressive monetary tightening will turn this external shock into a collapse in domestic demand, with potentially more severe consequences.

His conclusion is specific and direct: for most workers, maintaining a job in a 4% inflation environment is far more acceptable than facing unemployment in a 2% inflation environment.

Slowing monetary growth and raising interest rates do not solve the fundamental supply shortages; they merely redistribute the burden—and often shift it onto workers. In such circumstances, rate hikes are essentially trading employment losses for a reduction in an inflation figure that the central bank is already powerless to eliminate, making it a losing proposition.

The central bank’s proper role: defend the demand side and prevent second-order effects

Since it cannot “beat” supply shocks, what should the central bank do? Salter provides a clear role.

During geopolitical crises, the most effective role for monetary authorities is to stabilize the demand side. Specifically: when financial stress indicators signal trouble, the central bank can provide liquidity to prevent financial pressures from amplifying shocks; reassure markets that the banking system and capital markets will operate normally; and use routine open market operations to prevent widespread collapse of investment and employment.

Salter emphasizes that the real danger is not the initial surge in energy prices, but the panic among investors, tightening credit conditions, or collapsing market confidence that trigger a self-reinforcing economic downturn. The central bank’s task is to prevent these “second-order effects,” not to confront the “first-order shocks” that it cannot change.

Public trust is built on accurate judgment, not mechanical responses to every price increase

Salter anticipates criticism: tolerating temporary high inflation—won’t that unanchor inflation expectations and damage the central bank’s credibility?

His response is that credibility is not built by mechanically reacting to every price increase but by accurately judging the sources of inflation and responding appropriately. If the public understands that the central bank can distinguish between supply shocks and demand shocks, credibility can be maintained.

Salter believes that, with inflation expectations anchored, the best strategy is often to “ride through” the initial inflation impulse—tolerate temporarily higher overall inflation—and communicate clearly to the market that the shocks are external and temporary. He explicitly states that central bank officials should plainly tell the public: price surges are the result of geopolitical events beyond the control of monetary policy—The Fed cannot drill for oil nor end a war.

The worst policy mistake, Salter concludes, is rushing to tighten prematurely—before war-driven inflation pressures have begun to subside—deepening the economic downturn and causing avoidable losses. War makes society poorer, and this fact cannot be ignored; the best monetary policy can do is prevent the adjustment costs from becoming higher than necessary.

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