The Federal Reserve announced Wednesday that it will leave interest rates unchanged, noting higher risks of both inflation and unemployment. But bigger challenges lie ahead.

The Fed’s central task is inflation. Inflation peaked at 9% in June 2022 and hasn’t hit the 2% target since February 2021. A healthy institution would do some profound soul-searching. The Fed’s current Flexible Average Inflation Targeting strategy was designed to avoid deflation when interest rates are stuck at zero. Clearly that isn’t today’s problem. Appropriately, the Fed is beginning a review of its strategy.

It isn’t hard to divine why inflation surged. The federal government met the Covid-19 pandemic with a river of money. It spent $6.6 trillion in 2020, much of it in checks to people and businesses. The Fed helped by lending additional money, propping up asset prices, and keeping interest rates down.

This is the standard approach to a war or similar existential crisis: spend like crazy, borrow and print money to do it, and keep interest rates low. Inflation is part of the package. It’s essentially a wealth tax on bondholders to finance the spending. A spurt of inflation has followed every U.S. war since the American Revolution.

Inflation accelerated in 2021, even though Covid was subsiding and the economy was recovering. This is because the government continued its spending binge, and the Fed kept rates at zero for a full additional year.

The Fed blames supply and relative-demand shocks for the surge in inflation. But while the pandemic might have accounted for the rise in Peloton prices relative to wages, economywide inflation occurred only because the Fed and Treasury gave people enough extra money to spur higher prices all around.

This “supply shock accommodation” has also happened before. The 1970s oil shocks didn’t directly cause inflation; inflation occurred because the Fed accommodated the shocks, choosing greater inflation instead of a worse recession.

The Fed will have to make hard choices again. President Trump’s tariffs and trade war, if not swiftly abandoned, will cause another stagflationary supply shock, raising prices while reducing the economy’s productive capacity. The Fed will face an unhappy choice between more inflation and somewhat more contraction. Lower interest rates won’t do much to goose an economy with inflation-skittish markets. The political, institutional, budgetary and financial repercussions of higher rates mean that promptly raising rates to combat inflation will be nearly impossible.

So far, there is little sign that the Fed acknowledges the need for hard choices and a fundamentally new strategy, preferring instead to focus on trying to “manage expectations.” Yet nobody in Washington says that fueling the post-pandemic spike in inflation was a good choice.

So, what should the Fed do to avoid a repetition? The central bank defines “price stability” as 2% inflation on a forward-looking basis. Some say it should again “look through” a tariff-induced increase in the price level. But people are really mad about higher prices. Ignoring them is a bad idea. Instead, the Fed should take several steps:

• Pledge to make up any overshoots in inflation by tightening monetary policy. The Fed has previously committed to reverse undershoots by allowing more inflation to bring prices back. That promise should go both ways. Confidence in lower future prices can restrain inflation today.

  • Use its independence. The Fed should refuse to buy trillions of dollars in Treasury debt, finance Treasury handouts or hold down rates to weaken the dollar.
  • Distrust forecasts. They were dramatically wrong before and will be wrong again.
  • Instead, react quickly to inflation when and if it breaks out. No more waiting for “transitory” inflation to disappear. Promise quick, data-dependent reactions.
  • Tolerate relative price movements. It isn’t the end of the world if some prices and wages go down while others go up. Avoid perpetual inflationary bias.
  • Remove the financial hostage dynamic. Banks and other financial institutions are vulnerable to higher interest rates or a recession. Require them to increase their capital and reduce short-term debt and interest exposure, thus avoiding the need for another bailout. Allow narrow banks.
  • But the Fed can’t control inflation alone. If Congress and the president wish to avoid inflation—and its electoral consequences—in the next crisis, they must also prepare by doing the following:
  • Forswear stimulus spending. Everyone can see that the Covid and post-Covid spending was overdone. Spend wisely on measures that clearly and narrowly address the crisis at hand.
  • Restore fiscal space. To borrow in a crisis without driving up interest rates or inducing inflation, the government must assure investors that additional borrowing can and will be paid back by tax revenues or spending cuts. Tax, spending and growth reform buy good credit.

• Borrow long. If the Fed raises rates, interest costs on the debt rise. That adds to the deficit and can boost inflation. Move the Treasury to long-term borrowing, and ensure the Fed doesn’t throw away that insurance with bond purchases.

A good strategy today is the only way to avoid an inflation surge when the next crisis inevitably hits.