Do High Interest Rates Fix High Inflation?
Do High Interest Rates Fix High Inflation?
Published: June 2023 In prior articles and newsletters, I’ve explored the causes of consumer price inflation over time. In short, the rate of consumer price inflation in an economy comes from a combination of 1) money supply growth and 2) significant changes in productivity and/or resource abundance...
-Periods of technological stagnation, societal dysfunction, the need for resiliency over efficiency, war, and scarce natural resources tend to all contribute to the experience of inflation due to their negative affects on the supply of goods and services. On the other hand, periods of technological improvements, labor specialization, the sacrifice of resiliency for efficiency, geopolitical and civic peace, and abundant natural resources tend to all contribute to the experience of disinflation due to their positive affects on the supply of goods and servicesWeird. Wasn't the technical advancement of the 60s/70s higher than in the last 20 years (2000-2020)? Although back then inflation was much higher than now?
I'm becoming more and more convinced that we (including economists) don't really understand inflation. It seems to be a product of the zeitgeist. If we believe there is inflation it will be their, if we don't, it won't. That is at least the case for the demand side of the equation. The supply side of the equation is affected by scarcity, either man made or natural. I don't think money supply or interest rates have nearly as much effect as we've long believed.
Economists admit they don't understand the causes of inflation, but they have some understanding why they can't understand it.
One of the main drivers of inflation is inflation expectations. If people (and investors, and companies, and countries, etc.) expect inflation and rates to go up, they will spend cash now instead of holding it. This itself of course drives inflation! And likewise if they expect inflation and rates to go down they'll hold cash and and bonds instead of investing in securities which might devalue during an economic slowdown. This makes inflation a very fickle phenomenon which cannot easily be anticipated and planned for like other economic trends.