With the US and Israel bombarding Iran, the surge in oil prices brings to mind the inflationary energy shocks of the past half century. But that may be the wrong way to think about what’s unfolding in the economy today.

While the 1970s and 2022 shocks supercharged US inflation, a sustained conflict with Iran would primarily hit the American economy through slower growth. Modern central bankers know to look through supply-driven energy price volatility when adjusting policy rates, and rising bond yields suggest that markets may be misjudging the Federal Reserve’s reaction function. In fact, today’s Fed policymakers are likely to understand the growth-dampening effects of the war on a brittle labor market, and geopolitical developments are unlikely to lead to policy rates that are higher for longer.

First, consider the inflation backdrop. The energy price spike comes against subdued inflation pressure in the rest of the consumer price index. Only about 15% of the CPI by weighting is currently inflating at a pace of 4% or more. The same statistic was at 62% when Russia invaded Ukraine in February 2022. Although pump prices are still among the most salient in household inflationary psychology, consumers aren’t likely to experience the shock as part of a broad increase in the price level. And while high prices have become a persistent complaint, inflation expectations have been relatively well-anchored in recent quarters, as measured by swaps and consumer surveys.

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