On September 16, the Federal Reserve raised its target range for the federal funds rate by 25 basis points, to 3.75–4.00 percent. The decision was unanimous. Its statement acknowledged uncertainty associated with geopolitical developments, but also emphasized resilient domestic spending and elevated inflation. The stated purpose of the increase was to bring inflation back to the 2 percent objective more quickly. [FOMC statement, September 16, 2026]
Why tighten monetary policy in a more uncertain world? The question becomes less puzzling once we stop treating geopolitical risk as another name for weak demand. A geopolitical shock can depress spending while making production more expensive. The policy response then depends on which effect dominates, how persistent it is, and the horizon over which the central bank is looking. [Caldara, Conlisk, Iacoviello, and Penn (2026)]
What the September decision tells us—and what it does not
The accompanying projections help explain the decision’s economic backdrop. The median participant projected 2026 real GDP growth of 2.3 percent, PCE inflation of 3.7 percent, and core PCE inflation of 3.4 percent, measured from the fourth quarter of 2025 to the fourth quarter of 2026. Projected unemployment averaged 4.1 percent in the final quarter. These are conditional forecasts, not observed year-end outcomes or policy commitments. They describe an economy expected to keep growing while inflation remains above target. [September 2026 economic projections]
My reading is that the Committee judged persistent inflation to warrant additional restraint despite geopolitical uncertainty. That is different from saying that geopolitical risk caused the rate increase: the statement does not quantify its contribution relative to other influences on inflation and activity. [FOMC statement, September 16, 2026]
Nor should the decision be reduced to a mechanical response to energy prices. On September 3, Christopher Waller argued that feared spillovers from higher energy costs into broader prices had not materialized to the extent he had worried about, and that longer-term inflation expectations had not risen significantly. He nevertheless made the case for a possible increase conditional on renewed deterioration in the inflation data. His pre-meeting remarks illustrate the distinction between an inflation risk and evidence that the risk has already materialized. [Waller, September 3, 2026]
Geopolitical risk: the horizon matters
This distinction between immediate disruption and subsequent inflation pressure is central to my paper with William Ginn, “Monetary policy reaction to geopolitical risks in unstable environments,” published in Macroeconomic Dynamics in 2025. Using a panel of 18 economies over February 2000–February 2022, we estimate an augmented Taylor rule with constant and time-varying local projections. [Ginn and Saadaoui (2025)] [Full paper]
The paper reports a horizon-dependent pattern: interest rates initially decline, whereas the response becomes positive at medium horizons. In the time-varying analysis, accommodation at roughly one to two months is interpreted as cushioning weaker consumer sentiment; tightening around twelve to fifteen months gives greater weight to inflationary pressures. The country applications of that time-varying framework concern the United Kingdom, Canada, and Israel. These results are historical evidence, not a Fed-specific forecast for September 2026. [Ginn and Saadaoui (2025)] [Full paper]
The policy interpretation is important. A central bank need not change its objectives to change its response. It may initially place greater weight on a sudden deterioration in demand, then confront a different balance of risks as the consequences for prices become clearer. A stable mandate can produce different interest-rate decisions as the economic effects of the shock evolve.
But the estimated horizons are not a timetable for policymakers. Nor does a rate increase during geopolitical tension establish that the economy has entered the “medium-run phase” of an identified shock. Several disturbances may be operating simultaneously. The paper offers a framework for asking better questions, not a causal diagnosis of a single meeting.
Weak activity and inflation can arrive together
Consider a disruption that both undermines business confidence and interrupts access to important inputs. The first effect weakens expenditure; the second raises costs. Lower activity therefore does not, by itself, reveal whether the net effect on inflation will be positive or negative. [Caldara, Conlisk, Iacoviello, and Penn (2026)]
Recent evidence reinforces this point. In “Do geopolitical risks raise or lower inflation?”, Caldara, Conlisk, Iacoviello, and Penn (2026) find that geopolitical risk tends to precede higher inflation and weaker activity, with substantial variation across countries and historical periods. Their analysis highlights how commodity-price increases and currency depreciation can outweigh the disinflationary effects of weaker sentiment and tighter financial conditions. [Caldara, Conlisk, Iacoviello, and Penn (2026)]
The implication is not that every geopolitical disturbance demands higher interest rates. It is that an argument for easing cannot rest on weaker activity alone. Equally, an argument for tightening cannot rest on a higher oil price alone. The relevant question is whether the disturbance is likely to leave inflation persistently above target after its initial effects have passed.
From exchange rates to geopolitical risk: Aizenman, Hutchison, and Noy
My recent EconMacro post, “Inflation Targeting and Real Exchange Rates: From Equations to Mathematica,” revisits Appendix A of Aizenman, Hutchison, and Noy (2011). The connection with geopolitical risk goes beyond the exchange rate as a transmission channel. The central idea is to take the logic of their augmented policy rule and replace the exchange-rate term with a geopolitical-risk term. [Inflation Targeting and Real Exchange Rates: From Equations to Mathematica]
For a compact illustration, write the adapted rule as:
\[r = a\pi + by + c_g g.\]
Here, \(r\) is the real interest-rate deviation, \(\pi\) the inflation deviation, \(y\) the output gap, and \(g\) geopolitical risk relative to a reference level. The coefficient \(c_g\) measures the direct response to geopolitical risk, holding inflation and output fixed. Its sign is not inherited from the exchange-rate coefficient in the original model.
A negative \(c_g\) means that higher geopolitical risk lowers the rate prescribed by the rule, other things equal. A positive coefficient means that it raises that rate. This additional term need not represent a separate objective of reducing geopolitical risk itself. It can instead summarize information about future inflation and activity that is not yet captured by their current values.
Importantly, \(c_g = 0\) does not make monetary policy unresponsive to geopolitical risk. The central bank can still react to the inflation and output movements generated by the disturbance. With fixed policy coefficients, differentiating the illustrative rule gives:
\[\frac{\mathrm{d}r}{\mathrm{d}g} = a\frac{\mathrm{d}\pi}{\mathrm{d}g} + b\frac{\mathrm{d}y}{\mathrm{d}g} + c_g.\]
The total response therefore combines the inflation channel, the output channel, and the direct geopolitical-risk term. With positive responses to inflation and output, a disturbance that raises inflation while lowering output creates opposing pressures on the policy rate. The sign of \(c_g\) alone cannot determine the net response.
This is an adaptation of the policy rule, not a claim that geopolitical risk behaves like an exchange rate. The appendix’s exchange-rate equation and numerical calibration cannot simply be transferred unchanged: a structural geopolitical-risk model would need to specify how risk affects demand, costs, and expectations. The original appendix is also static; it cannot by itself explain how a response changes across horizons. [The model and its equations]
This is precisely where our Macroeconomic Dynamics paper provides the empirical connection. We estimate a Taylor rule augmented with geopolitical risk, incorporating interest-rate inertia, lagged inflation and output variables, and country fixed effects. The empirical interest rate is nominal, unlike the real-rate deviation in the compact illustration above. [Ginn and Saadaoui (2025), Section 3.1]
The local projections then move beyond a single coefficient to examine how the response unfolds over time. The estimated pattern of initial accommodation followed by medium-run tightening is consistent with a changing balance between weaker sentiment and inflationary pressure. These horizon-specific responses should not be confused with the direct coefficient \(c_g\) in the illustrative rule. [Ginn and Saadaoui (2025)]
The link between the two posts is therefore not merely that exchange rates matter during geopolitical crises. It is that geopolitical risk can itself enter an augmented monetary-policy rule, while the sign, strength, and timing of the resulting response remain questions for economic analysis and empirical evidence.
A domestic decision with international consequences
The exchange-rate perspective becomes especially relevant outside the United States. Iacoviello and Navarro (2019) show that U.S. monetary tightening shocks can reduce activity abroad, with larger effects in emerging economies when external vulnerabilities are greater. Crucially, their evidence concerns identified policy surprises; an announced rate increase is not necessarily an equally large surprise. [Iacoviello and Navarro (2019)]
Consider, then, an emerging economy already facing higher imported input costs and weaker domestic demand. An additional tightening of external financing conditions could make its policy problem harder, particularly if depreciation increases inflation or strains foreign-currency balance sheets. This is a possible transmission mechanism, not a forecast that every currency must fall after this Fed decision. Exposure and initial conditions matter. [Iacoviello and Navarro (2019)]
The analytical lesson is to distinguish the original geopolitical disturbance from the international consequences of the monetary response to it. Two countries facing the same geopolitical news need not face the same inflation outlook—and need not choose the same policy.
The September decision should therefore be read neither as proof that geopolitical uncertainty is unimportant nor as proof that it inevitably requires tightening. It illustrates the more demanding question that monetary policy must answer: which consequences of the shock should policy accommodate, and which threaten lasting instability?
A more dangerous world does not supply a simple interest-rate rule. It makes understanding the transmission mechanism more important.
Research references
Aizenman, J., Hutchison, M., and Noy, I. (2011). Inflation targeting and real exchange rates in emerging markets. World Development, 39(5), 712–724.
Caldara, D., Conlisk, S., Iacoviello, M., and Penn, M. (2026). Do geopolitical risks raise or lower inflation? Journal of International Economics, 159, 104188.
Ginn, W., and Saadaoui, J. (2025). Monetary policy reaction to geopolitical risks in unstable environments. Macroeconomic Dynamics, 29, e90.
Iacoviello, M., and Navarro, G. (2019). Foreign effects of higher U.S. interest rates. Journal of International Money and Finance, 95, 232–250.