There is a general reactions of central bankers to raise policy rates to combat inflation. Similarly, they reduce rates to promote growth. But does it really work in long-term.
While demand-led inflation or demand-led growth can be controlled by raising interest rates in short-term, it fails to address the issues involving inflation and growth over a period of time. But in Long-Term, Consumer behavior and resultant investment cycle tend to adjust with the policy rates, high or low, if it continues for a long period of time.
In the case of Cost-push inflation, as at present, the policy rate changes does not work at all. Present inflation is the result of supply-side disruptions. In 2020, factories in the world were closed for a considerable period of time resulting in loss of production. Additionally, very low capacity addition was affected after Covid-19 hit the world. The incremental consumption continued to rise in the intervening period. This led to shortages resulting in inflation.
The crisis has been aggravated due to boycott of China and now Russia. The current global inflation is the result of supply-side constraints, which cannot be controlled by raising interest rates as you cannot curb genuine consumption needs by raising interest rates. As there is shortage, any increase in costs due to increase in interest rates will be passed on to consumer leading to higher inflation.
Only and only solution in current crisis is improving the supply side.
Knee-jerk raising of rates is increasing the risk of recession in the near future. This may also lead to increasing delinquencies as those contracting debt before rate increases may find it difficult to meet their interest commitments due to sharp rise in short-term.
