How does increasing interest rates curb inflation in the current circumstances?

I get how increased interest rates can curb spending and thus dampen inflation.

But my understanding is that a big factor in the current rise in inflation is the cost of fuel. Cost of fuel rises >> businesses must put up their prices because they're spending more on fuel >> lots of other things rise in price too.

Given that the cost of fuel is out of the consumer's control, how does increasing interest rates help in this context?

I get the feeling that there's a feeling that a recession now is better than a recession later.

Purple said:

I get the feeling that there's a feeling that a recession now is better than a recession later.

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I would speculate that the sharp cost of living increase will bring about a recession on its own. So what's the thinking - raise interest rates sharply also to bring on the pain quickly? Get it over with as soon as possible?

I would argue Lagarde and Vonderlyn are beyond incompotent and are beggaring the entire continent over the Ukraine, the vast majority of the inflation is caused by energy which we have stupidly decided to just pay russians more for. The sanctions imposed by the west (EU and U.S) are not working and we are paying more for energy than ever before. With Italy swinging to the right it will be a very difficult time for the eu in the next 6 months as ordinary people are going to be clobered by bills/job losses and a large recession.

LDFerguson said:

I would speculate that the sharp cost of living increase will bring about a recession on its own. So what's the thinking - raise interest rates sharply also to bring on the pain quickly? Get it over with as soon as possible?

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I suspect the plan Liam is to correct the decline in the Euro vs the Dollar, which has been a major driver in the ongoing price spike in fuel.

LDFerguson said:

I would speculate that the sharp cost of living increase will bring about a recession on its own. So what's the thinking - raise interest rates sharply also to bring on the pain quickly? Get it over with as soon as possible?

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Yea, that sort of thing.

@LDFerguson, we have a weird situation where there's stagflation but a labour shortage. That's really not a good thing. Inflation in Poland is almost 16% and climbing. That's totally bonkers.

Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon”

There was huge monetary expansion starting in 2008 and given impetus by the pandemic. Surprisingly (in my opinion) inflation didn't break out until the war in Ukraine and the corresponding food/energy price increases.

If there was ever a time when inflation was not a monetary phenomenon, that time is now, or at least much less so than usual. The traditional interest rate response seems unlikely to succeed.

Spending will shift from all areas to energy and energy dependant areas. Increasing borrowing costs at such a time seems misguided.

Defending the currency is of course important. Energy is priced in USD, not so long ago €1 was $1.3 today its just $1, The ECB needs to halt that decline. However I think we will see a rethink on interest rate rises over the course of the next 9 to 12 months, probably in the US first.

T McGibney said:

I suspect the plan Liam is to correct the decline in the Euro vs the Dollar, which has been a major driver in the ongoing price spike in fuel.

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Likewise a big part of the ECB's 2014 quantitative easing programme was the positive effect it would on euro area exports by devaluing the euro.

The euro fell from $1.33 in 2014 to $1.10 in 2015 and the volume of exported goods grew by 9% in a year (both are big changes and not unrelated).


The ECB will claim it doesn't target the exchange rate of the euro of course

T McGibney said:

I suspect the plan Liam is to correct the decline in the Euro vs the Dollar, which has been a major driver in the ongoing price spike in fuel.

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Yes that's the knub of it now alright, but the real issue is that Lagarde and Philip Lane were wrong on inflation and were way too slow in raising interest rates. I think Phillip lane has a lot of egg on his face because only a few months ago he was still talking about transitory inflation and denying they would need to raise interest rates at all.

I think they were trying to shield the governments some of the biggest borrowers of all (Ireland being one of the biggest) from higher interest rates since they loaded up on so much debt especially during covid
Since government spending has exploded since covid started, any rise in interest rates is bound to ease inflation since curtailing that government spending will pull a lot of demand out of the economy again

joe sod said:

Yes that's the knub of it now alright, but the real issue is that Lagarde and Philip Lane were wrong on inflation and were way too slow in raising interest rates. I think Phillip lane has a lot of egg on his face because only a few months ago he was still talking about transitory inflation and denying they would need to raise interest rates at all.

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I wondered at the time if he really believed that. Central Banks around the world have been artificially keeping the cost of debt low for the last 14 years. The wheels were going to come off that at some stage and Covid and Ukraine were just the bumps on the road.
With the Pension industry turning Bonds into derivatives the way mortgages were turned into derivatives 20 years ago, the Chinese economy funded by selling land to itself and quantitative tightening around the world unavoidable, all talk of soft landings and transitory inflation was and it fanciful.

joe sod said:

I think they were trying to shield the governments some of the biggest borrowers of all (Ireland being one of the biggest) from higher interest rates since they loaded up on so much debt especially during covid
Since government spending has exploded since covid started, any rise in interest rates is bound to ease inflation since curtailing that government spending will pull a lot of demand out of the economy again

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The problem with the ECB is that it has become way too comfortable with high inflation and it way too concerned with the political fallout of making the right economic choices.

Yea I think the US and Europe can get away with printing money because nobody can refuse payment in those currencies. There is no alternative to the US and Europe, I know that is Putin's and China big bug bear, so far they have been unable to form an alternative economic block and Putin's war has driven a coach and 4 horses through that dream.
But it is noteworthy that even yesterday Putin was still ranting about needing an alternative to the West.
The problem the ECB were facing is that they were creating too much of a differential between the dollar and the euro with their ultra low interest rate policy. The danger was that the euro would be abandoned in favour of the dollar if this wasn't addressed

joe sod said:

The danger was that the euro would be abandoned in favour of the dollar if this wasn't addressed

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And since hydrocarbons are traded in US$ those chanced in exchange rates increased inflation in the EUZ.