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The Federal Reserve can keep rates high or raise them further if inflation appears persistent, demand remains too strong, or longer-term inflation expectations risk becoming unanchored. It can also hold rates steady while it assesses incoming evidence, explain its expected policy path, and use balance-sheet tools when appropriate. None of these tools can directly produce more oil or repair a supply disruption: the Fed must weigh the risk of persistent inflation against the cost of slowing economic activity and employment.
Why inflation can keep rising after a rate increase
A rate increase does not immediately lower prices. The federal funds rate influences other borrowing costs and broader financial conditions, which then affect spending, economic activity, employment, and inflation. Those effects arrive with a lag, as the FOMC’s August 2025 strategy statement explains.
Meanwhile, a new shock can push prices up even as earlier rate increases are beginning to cool demand. A higher price for a particular product is also different from persistent, broad inflation: the source, duration, breadth, and expected follow-through all matter. A price increase after a hike, by itself, does not establish that the hike caused inflation to worsen.
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The Fed’s goals, set by Congress, are maximum employment and stable prices. The FOMC’s longer-run inflation goal is 2 percent, measured by the annual change in the personal consumption expenditures (PCE) price index; maximum employment is not a fixed numerical target. The Committee considers the economic outlook and incoming information, including reports and surveys from households, businesses, and financial-market contacts.
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Its assessment turns on several related questions:
- What is driving the increase? Strong demand and a supply disruption create different problems. Higher rates can restrain demand, but cannot directly restore supply.
- Is inflation persistent, broad, and large? A temporary or sector-specific price movement is not equivalent to persistent inflation across the economy.
- Are expectations at risk? If people and businesses expect elevated inflation to continue, the risk of more persistent inflation becomes more important.
- What are the costs to employment and activity? A negative supply shock can push prices higher while reducing economic activity, putting the Fed’s goals in tension.
- How much of earlier policy tightening has yet to take effect? Because policy works with a lag, the latest inflation reading may not capture the full effect of prior decisions.
A 2025 Federal Reserve research paper by its authors says policymakers may allow inflation to move away from target in response to certain supply shocks or sectoral dynamics, while remaining prepared to respond forcefully to large inflation shocks or a risk that expectations will become unanchored. That paper is research, not a binding FOMC rule, and does not imply concurrence by all Board members or staff.
What options does the Federal Reserve have?
Keep rates steady while assessing the outlook
The FOMC can hold its policy rate unchanged and evaluate whether previous moves are still working, whether inflation is temporary or persistent, and how the outlook is changing. A pause is an option under an outlook-based framework that accounts for policy lags; it is not a guarantee that inflation will fall or a prediction of a particular meeting decision.
Maintain or increase restraint
If evidence points to persistent inflation, demand that is still too strong, or inflation expectations becoming unanchored, the FOMC can keep policy restrictive or raise rates further. The Federal Reserve’s policy principles explain that higher real interest rates tend to slow economic growth and that firms tend to raise prices less rapidly when sales growth slows. They also describe why persistent inflation may call for the policy rate to rise more than one-for-one over time, increasing the inflation-adjusted cost of borrowing.
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1Clear out junk files and repair common Windows errors2Fix the driver behind crashes, sound loss and screen glitches3Repair Windows errors before they cause bigger problemsThat is not a mechanical response to one monthly inflation report. The FOMC weighs the evidence and the effects on both parts of its mandate.
Communicate how policy may respond
Forward guidance—communication about the likely policy path—can shape financial conditions by influencing expectations. It lets the Committee explain how its assessment could change as inflation, employment, and activity data arrive.
Use balance-sheet tools when appropriate
The Fed’s toolkit also includes balance-sheet policies. Large-scale asset purchases have been used especially when the policy rate is constrained near its effective lower bound. The Fed implements its rate target with tools that include interest on reserve balances and the overnight reverse repurchase facility rate. These instruments are not substitutes for producing scarce goods or undoing a supply shock; the FOMC uses them as part of its broader policy approach.
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Why supply-driven inflation presents a difficult tradeoff
When a supply disruption raises prices and weakens activity at the same time, broad rate increases may reduce demand and limit follow-on inflation, but they can also put more pressure on employment. Rates do not fix the underlying disruption. In a September 26, 2025 speech, Federal Reserve Vice Chair for Supervision Michelle W. Bowman described supply shocks as challenging because they can move economic activity and inflation in opposite directions, putting the Fed’s dual-mandate goals in conflict.
The FOMC’s framework says that when maximum employment and price stability are not complementary, it considers how far each goal has departed from its desired level and the different time horizons over which they may return to levels consistent with the mandate. The choice is therefore not simply “raise rates” or “ignore inflation”; it is a judgment about the persistence and risks of inflation and the costs of each response.
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A dated example: the July 2026 Monetary Policy Report
The Federal Reserve’s Monetary Policy Report submitted to Congress on July 10, 2026 reported that PCE inflation was 4.1 percent over the 12 months ending May 2026, while core PCE inflation was 3.4 percent over that same period. It also reported that the Dallas Fed trimmed-mean PCE measure declined from 2.6 percent in May 2025 to 2.4 percent in May 2026. These are distinct measures and period-specific figures, not a statement of inflation on a later publication date.
The report attributed some recent price pressure to tariff-related changes and an energy-price surge after conflict in the Middle East. It said the FOMC had maintained a federal funds target range of 3.50 to 3.75 percent since the beginning of 2026, as of the report. That historical range should not be read as the current target.
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