Many people easily attribute inflation to external events, such as geopolitical conflicts driving up oil prices. However, Chicago Federal Reserve President Austin Goolsby reminded the market to distinguish between two completely different causes of price increases: one is a one-off supply shock, and the other is excessive domestic demand. The corresponding Fed actions for these two situations differ greatly, and understanding this distinction is key to grasping the core meaning of his speech. A supply shock, simply put, means that there is less supply and higher procurement costs, not that people have an excessive desire to spend money; excessive demand, on the other hand, means that people and businesses have more money in their pockets, and everyone is rushing to buy goods and services, so even if there is no problem with the supply of goods, prices will still be driven up. Goolsby stated that if this round of inflationary rebound is not solely caused by oil supply shocks but is driven by more persistent internal factors, then the Federal Reserve will need to employ "aggressive" and "preemptive" policy measures to address it. Chicago Federal Reserve Bank President Austin Goolsby explained that if the root cause of price increases is overheated demand—primarily from service sector consumption and business investment demand driven by the artificial intelligence boom—rather than just supply disruptions caused by the Iranian situation, then a mere 25 basis point (0.25 percentage point) rate hike is likely insufficient. Goolsby told reporters at the Official Monetary and Financial Institutions Forum (OMFIF) on Monday, "We are increasingly feeling that some of the inflationary pressures may be due to overheated demand. And service sector inflation may not simply disappear on its own." Service sector inflation refers to price increases in intangible services such as hairdressing, hotel accommodations, food delivery, healthcare, and logistics. Unlike oil prices, service prices, once they rise, are often difficult to fall back down. Oil prices, affected by war, may fall quickly after the conflict eases; however, once wages and rents rise, they take much longer to come down, which is why the Federal Reserve has been closely monitoring service sector inflation. He continued, "If analysis confirms that the main driver of inflation is overheated demand, it means that the Fed's interest rate hikes, and the speed at which they are implemented, will be stronger and earlier than when facing a simple supply shock." Goolsby made these remarks as the US was grappling with a persistent wave of inflation. This year, inflationary pressures have intensified, with the market widely believing the trigger was the tense situation in the Middle East, leading to anticipated tightening of oil supply and a subsequent surge in oil prices. Oil prices will transmit to the entire economic chain: transportation costs rise, chemical raw material costs rise, and ultimately the cost of almost all goods increases—a typical supply shock. However, Goolsby argues that all price increases cannot be attributed to oil prices; the data must be carefully analyzed to see how much is actually driven by overheated demand. Goolsby noted that supply shocks have become increasingly frequent and severe in recent years. Last week, the Fed just completed an interest rate hike, aiming to curb the rate of price increases. According to the median forecast in the Federal Reserve's "dot plot," the Fed officials' current baseline expectation is: another 25 basis point increase this year; and a pause in rate hikes until 2027, with interest rates remaining high. Goolsby stated that if it is ultimately confirmed that inflation is primarily caused by energy supply shocks, then the current plan might be sufficient to control prices. However, if subsequent data provides evidence that overheated demand is the main driver, then the planned rate hikes may not be enough. In a separate speech at the same forum, Goolsby also warned that the current massive capital expenditures in artificial intelligence could "overflow existing sectors, pushing up total output beyond what the economy can absorb." In simpler terms: many companies are currently spending heavily on computing power, building data centers, and hiring AI engineers. This huge investment itself represents demand. If this AI investment boom becomes too large, and the entire economy has to absorb so much new investment at once, the supporting resources such as labor, electricity, and land will not keep up, driving up the prices of various resources. Originally, AI was an expansion within a single industry, but the spending effect spreads to the entire economy, pushing aggregate demand beyond the economy's carrying capacity, thus fueling inflation. It's not the price of AI products that's rising, but the prices of the various resources consumed in developing AI. He emphasized, "Once it's confirmed that demand is overheating, there's no room for ambiguity in how the Federal Reserve should respond." Here's a crucial point: Goolsby doesn't have a vote on the FOMC (Federal Open Market Committee) this year; he can only express his opinions, not directly participate in interest rate decisions. He won't become a voting member until 2027. Therefore, his speech represents an important direction of thinking within the Fed, but it doesn't mean the Fed has already set its policy. US inflation has been above the Fed's 2% long-term target for five consecutive years. The Fed's most valued inflation indicator is the Personal Consumption Expenditures Price Index, or PCE. The PCE is the Fed's preferred inflation data and differs slightly from the more commonly heard CPI. The CPI focuses more on a basket of consumer goods for urban residents; the PCE has a broader scope, including more corporate reimbursements and healthcare expenditures, and the Fed prioritizes this indicator when formulating policy. The latest July PCE year-on-year growth rate is 3.7%; while in February, when the Middle East conflict broke out, the PCE was only 2.8%, showing a clear upward trend in inflation. Goolsby said, "Our most important task now is to distinguish the causes of the inflation rebound. The first possibility: the inflation rebound comes from a supply shock, and this shock will subside in the short term. The second possibility: the supply-side shock persists and will not disappear quickly. The third possibility: the price increase comes from the AI investment boom plus demand in the service sector, and is basically unrelated to the supply shock. These three scenarios must be assessed separately and cannot be mixed together. Of these three scenarios, two require the Fed to further raise interest rates; only the first scenario, a short-term, one-off supply shock, allows the Fed to choose to 'see through' the inflation, that is, temporarily refrain from strong interest rate hikes and avoid forcibly suppressing the economy, waiting for the supply side to repair itself. 'Seeing through' inflation is the Fed's old approach: one-off supply-driven price increases are only temporary disturbances and will not take root in the long term, so the central bank does not need to tighten monetary policy immediately. But if it is a demand-driven price increase, it cannot be ignored, and interest rates must be raised to cool it down." He explained that the responses to these three scenarios are completely different. As long as the root cause is overheated demand, whether that demand stems from service sector consumption or large-scale investment in AI, the nature is the same: when the total amount of spending exceeds the total amount the economy can stably supply, prices will continue to rise. This kind of inflation won't automatically disappear as geopolitical conflicts ease; it can only be addressed by raising interest rates, increasing borrowing costs, suppressing business investment and household consumption, and thus reducing aggregate demand. The market is now watching a series of subsequent economic data, such as wages, service sector prices, and consumer spending. If the data for the next few months continues to show strong consumption and investment, then the market should be prepared: the Federal Reserve may abandon its original plan and choose a larger and faster rate hike than anticipated by the dot plot. Conversely, if subsequent data shows that the price increase is mainly due to oil price transmission, and domestic consumption and business investment are not overheated, then the Federal Reserve will most likely maintain its current rate hike pace.