While moderately high oil prices are inflationary, extreme prices ($500/bbl) become massively deflationary by destroying demand across the entire economy. This paradox complicates the central bank response, as an initial inflationary shock could morph into a severe recessionary impulse.

Inflation from a supply disruption, like an oil price spike, will eventually fade. It only becomes persistent and embedded in the economy if governments try to 'help' consumers pay for higher costs with stimulus checks, which increases the broad money supply.

Despite oil prices doubling, the economy didn't slow down because energy now constitutes a historically low share of consumer budgets. Instead of cutting back, confident consumers simply drew down their savings to cover the higher cost, turning the energy shock into a pure inflationary impulse rather than a demand-destroying event.

While initial energy price spikes boost short-term inflation expectations, a sustained shock eventually hurts economic growth. This growth concern acts as a natural ceiling on long-term inflation expectations (break-evens), as markets anticipate an economic slowdown, preventing them from rising indefinitely.

Current oil prices are stuck in a dangerous middle ground. They fuel inflation across the economy but aren't high enough to trigger the demand destruction that would force central banks into decisive action, creating a prolonged inflationary environment.

Unlike the 1970s oil crisis, today's energy shocks cause demand destruction because consumers are weaker. In the 70s, people had decades of real wage growth. Today, after decades of wage stagnation, consumers have no financial cushion, forcing them to cut spending immediately when prices rise.

While rate hikes can't solve supply shocks like high oil prices, the Fed still acts to prevent the initial price increase from 'bleeding' into dozens of other items. This preemptive measure aims to stop a temporary shock from becoming entrenched, broad-based inflation, which would be much harder to control later.

Goolsbee pushes back against the idea that high wage growth prevents inflation from falling. He argues the dynamic is the reverse: prices are less sticky and rise first in response to a shock, followed by wages. This means seeing high wage growth while inflation falls is a normal part of the disinflationary process.

Investors often rush to price in the disinflationary outcome of an oil shock (demand destruction). However, the causal chain is fixed: prices rise first, hitting real spending. Only much later does this weaken the labor market enough to reduce overall inflation, a process that can take 9-12 months to play out.