Higher interest rates may not slow inflation, and central banks are partly to blame
Contrary to earlier assurances that interest rates would remain low until 2024, the Reserve Bank of Australia’s aggressive policy – being pursued by central banks globally – follows failures to forecast rising prices and may not be effective in achieving its objective.
Instead, the reserve bank’s actions may result in a combination of economic instability, inflation and rising rates – coinciding with great power competition and a difficult energy transition – which will exacerbate inequality, dilute living standards and frustrate ordinary people’s expectations.
Designed to reduce demand by slowing discretionary spending, higher interest rates will be counteracted by billions of dollars in federal government spending and tax offset payments. State governments, such as New South Wales and Victoria, have announced large expenditure programs. Even where these initiatives target essential infrastructure and living costs, they add to demand, effectively contradicting the RBA’s efforts.
In addition, higher interest rates cannot address supply side factors such as Covid-19, especially China’s dynamic zero approach, as well as geopolitical events, trade restrictions, resource scarcity, climate change and the powerful oligopolies in certain industries with pricing power. They will also not alter sanctions on Russia affecting food and energy supply and costs.
Higher interest rates can feed inflation. Businesses, many who have borrowed heavily during the pandemic, will pass on increased expenses to consumers. Increasing mortgage payments add to wage demands. Higher interest rates transfer cash from borrowers to lenders which if spent increases demand for goods and services and prices.
Plus, they can have adverse currency effects. With
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