How is raising interest rates supposed to help with the kind of inflation we are having now?

[bimble]

I really don’t get it at all. News says we’re looking at anything up to 17% inflation for the things we actually need to buy, like food. The planned response is to raise interest rates, ‘to reduce inflation’.
I have tried to understand it, but can’t, everything just says that if it’s more expensive to borrow then people will buy less & save more so there’s less money chasing the same products so the prices will go down . But how is that supposed to help when it’s absolutely basic things like milk and pasta and socks and general survival stuff that is the real issue?
If anyone can do an idiots guide to how this is supposed to help and not make it even worse for people who already have no spare & no savings would be grateful!

 

[rubbershoes]

It won't work. The root of the current inflation is oil prices. The increase in the cost of oil has fed through into higher prices for everything else.

Classic economic theory has raising interest rates as putting a brake on inflation exactly the way bimble says. But I can't see how it would work here with oil being the cause. And how much of that is due to Ukraine?

 

[bimble]

Exactly! The idea is to make people spend less but that would only have any impact on people who have savings deciding to not buy non-essentials anyway isn’t it ? Which how would that help with the price of the things people actually need.

 

[Pickman's model]

When you're young you might feel the people in charge must know more than you do about how things work but as you get aulder it becomes obvious it's like they're in an auld signal box, trying to avert disaster pulling levers at random with no notion of what they might do

 

[bimble]

Maybe it’s just the only lever they can see so they’ll pull it but it surely can’t be the case that the people who decide these things, who work at the monetary policy committee at the Bank of England really have a worse understanding of the likely outcomes of raising interest rates than bimble on urban does it can’t.

 

[cupid_stunt]

It won't work. The root of the current inflation is oil prices. The increase in the cost of oil has fed through into higher prices for everything else.

Classic economic theory has raising interest rates as putting a brake on inflation exactly the way bimble says. But I can't see how it would work here with oil being the cause. And how much of that is due to Ukraine?

And, gas prices of course. No doubt the Ukraine situation is not helping, hard to know by how much, as the increases started last year and the trajectory of average price increases continues along a similar line, I guess the assumption was that it would have levelled off some by now, but it hasn't because of the bloody war.



But, like you, I can't see how higher interest rates are going to help with inflation, when it's driven by everyday essentials such as energy, fuel, and indeed food.

 

[Pickman's model]

.

 

[bimble]

kabbes wake up and make it make sense.

 

[smmudge]

Yes the idea when inflation is fuelled by people putting money into the system (spending and borrowing lots), putting interest rates up encourages people to stop spending/investing so much and save it instead. That only works if we have a choice in what we're spending our money on, at the moment we're spending more on the things we need so don't have the choice but to pay it.

The only reason I can think they want to try it is because inflation has been high for a while now and they've kept interest rates low, which is really rare historically to have that disparity. And it hasn't worked to reduce inflation so they're going to try something else and see if that works. With no mind that there will probably be record numbers of home reposessions and people going bankrupt as they have to borrow to pay bills then can't afford to pay it back with all the interest.

 

[Wolveryeti]

Not checked the BoE reasoning on recent rate rises but an important way interest rate rises can have a disinflationary impact is via exchange rate effects. By raising rates you are inducing international capital to buy and hold sterling on deposit, causing sterling appreciation and lower import prices.

Of course it's a delicate balancing act as high rates will tend to tank the domestic economy through strangling access to affordable credit... if this causes supplier failures this can be inflationary too!

 

[kabbes]

kabbes wake up and make it make sense.

As has already been said, it might not work because raising interest rates is a response to demand-push inflation (ie an overheating economy), not supply-pull inflation (ie goods and services costing more)

Saying that, it might work. If you put interest rates up, the value of your currency rises because investors would rather hold bonds in your currency and get bigger returns. We’ve seen this with the dollar recently — the dramatic increases by the Fed have pushed the dollar sky-high. This strengthening of the currency makes imports cheaper, which reduces supply costs. Plus you have the same suppression of demand-cost inflation too.

The danger is that by increasing the value of your currency, you suppress exports. In addition, you are suppressing demand by raising interest rates. That can tip a country into recession. Plus, countries trying to outcompete on strengthening their currency can be very destabilising generally, which increases this risk.

[ETA: I see that Wolveryeti got in there while I was typing this. Ah well, good to have multiple explanations]

 

[Elpenor]

I don’t know much about economics (hence posting on this thread) but wonder if the raise interest rates approach is perhaps a case of fighting this new war with the last wars weapons

 

[Pickman's model]

I don’t know much about economics (hence posting on this thread) but wonder if the raise interest rates approach is perhaps a case of fighting this new war with the last wars weapons

Yeh it worked before in different circumstances

 

[ska invita]

Might dampen house prices which went up 11% in the last year ffs....might decrease rents also, which my friend who is moving this month says its hitting £900 a month for a 4 person flat share in south london

 

[kabbes]

It won’t decrease rents. In the medium term, it will probably raise rents. In the short term, I expect it won’t have much effect. In the long term, who knows what will happen? Lots of factors.

 

[SpookyFrank]

Have rents ever gone down?

 

[SpookyFrank]

And how much of that is due to Ukraine?

I think Ukraine is actually providing a pretty good cover for what are permanent, structural issues with fossil fuel supplies. You don't hear as much about 'peak oil' as you did ten years ago but the maths hasn't changed.

Gas and oil prices were rising and expected to keep rising for the forseeable, long before the Ukraine invasion began.

 

[rubbershoes]

Might dampen house prices which went up 11% in the last year ffs....might decrease rents also, which my friend who is moving this month says its hitting £900 a month for a 4 person flat share in south london

Saw a thing on the news yesterday that average rent in Manhattan has just gone above $5000 pm.

 

[tommers]

This guy thinks that interest rates rising is a deliberate plan to crash the economy....



Like, everything. Not just "some people can't pay their bills", he's talking about total collapse of the economy.

 

[bimble]

It will probably raise rents because of how mortgages will become more expensive won’t it?
It really does look like raise interest rates to reduce demand is just the only lever in the crap toolbox, so it’s getting pulled, just as it would be if it was the completely other kind of inflation, regardless of the fact that you can’t really reduce demand for food & fuel.

 

[platinumsage]

I think Ukraine is actually providing a pretty good cover for what are permanent, structural issues with fossil fuel supplies. You don't hear as much about 'peak oil' as you did ten years ago but the maths hasn't changed.

Gas and oil prices were rising and expected to keep rising for the forseeable, long before the Ukraine invasion began.

It's not peak oil its willful abandonment of investment in the sector.

 

[bimble]

This guy thinks that interest rates rising is a deliberate plan to crash the economy....



Like, everything. Not just "some people can't pay their bills", he's talking about total collapse of the economy.

Not a deliberate plan but he is saying he thinks it will be an epic fuckup. For exactly this reason, that raising interest rates addresses the opposite problem so will make things worse not better.

 

[tommers]

Not a deliberate plan but he is saying he thinks it will be an epic fuckup. For exactly this reason, that raising interest rates addresses the opposite problem so will make things worse not better.

Deliberate on the part of the govt then.



Just whatever this is on the part of the BoE.

 

[bimble]

Very cold comfort that it wasn’t just a stupid question.

 

[bimble]

Have rents ever gone down?

After the Black Death probably.

 

[ska invita]

I forget who it was , lefty economist , James Meadway perhaps, saying at the start of Covid it was fine for the state to pile on debt as it could inflate its way out of that debt
Could that be the rationale?

 

[platinumsage]

The current inflation bout began as an obviously supply-side phenomenon, but it has already been more persistent than a supply-side-only model would predict. Raising interest rates is about trying to stop it becoming embeded, not about the tackling supply-side part.

Combating inflation through raising rates tends strongly to lead to recessions. However such recessions are seen as the least of two evils compared to letting inflation spiral higher.

Look at the success Paul Volcker had in combating inflation in the late 70s early 80s through raising rates. It was deeply unpopular because of the recession it caused, but it worked, and ushered in a long period of economic growth and prosperity.

 

[bimble]

I kind of forgot that the recent very low rates are far from normal & there’s only really been anything close to it before in the crash to post war bit.

 

[SpookyFrank]

After the Black Death probably.

We just had a plague and still no respite

 

[SpookyFrank]

This guy thinks that interest rates rising is a deliberate plan to crash the economy....



Like, everything. Not just "some people can't pay their bills", he's talking about total collapse of the economy.

Let's just hope we don't have a babbling halfwit as prime minister when all this happens.

Oh wait...