Control of Inflation by Interest Rate?

Hyperinflation is now hitting Western society after a long period of very low interest rates and money printing combined with low inflation. State Banks are now raising interest rates to curb the inflation. But is this possible and advisable? Let see what common sense can say:

1. Interest rates can be seen as a cost of capital balancing risk. With very low interest rates anybody can borrow big money for any investment, many of which will not deliver, and that is not good. On the other hand, with high interest rates even clever people will not dare to invest, and that is not good. So a moderate interest rate maybe around 2-4% may be optimal. Instead we have had a period since 2008 with essentially zero interest rate with raising stock and housing markets to record levels.

2.  We now see a hyperinflation caused by increasing cost of energy because of a massive turn to solar and wind energy away from fossil and nuclear energy. But this is not true inflation but simply increased costs for energy production. 

3. But you cannot lower energy costs by raising interest rates, only increase,  and so the attempted policy of raising interest rates to curb inflation caused by an energy crisis cannot work. But it seems sound to give up the zero interest rate policy, which has caused a stock market and housing bubble, which is a form of hyperinflation although it is not included in the consumer price index used to measure zero inflation.  

4. On the hand, turning to more efficient fossil and nuclear energy production would lower consumer price index to a deflation, which would give people more for the money and it would be insane to seek to balance by letting interest rates go negative as has been the current policy.

5. So the way out of the coming crisis is to return to fossil and  nuclear energy production, and that is what we are now seeing coming. This is nothing which is controlled by a very low or very high interest rate, a moderate would be fine. The obsession by the Swedish State Bank boss Stefan Ingves to seek to control inflation up and down by the interest rate up and down, has been based on ideas in direct opposition to common sense and thus led to very negative consequences for people. 

Here is the variation of US inflation and interest rate over the period 1998-2022 showing that the interest rate does not control the inflation:

   

Den Livsfarliga Svenska Modellen

Åke Sundström skriver idag tänkvärt om Kung Ingves' Livsfarliga Experiment: Negativ ränta kombinerat med en tillväxt av penningmängden på 10% och därmed en reell inflation på kanske 8% med effektiv tillväxt på 2%, dvs ett gap mellan ränta och inflation på uppåt 10%.

I en sund ekonomi är räntan någon procent högre än inflationen, medan vi nu i Sverige tvärtom har en inflation som är betydligt större (uppåt 10%) än räntan.

Detta kan inte hålla i längden, vilket Kung Ingves är den förste att predika (och här), men trots detta är det Ingves som sätter en negativ ränta och samtidigt tillåter att pengar skapas ur intet.

Hur kan det få vara så galet? Sundström jämför med Schweiz.

Se också tidigare post om Ingves misslyckade ambition att styra ett visst fiktivt inflationsmått till 2% via negativ ränta i sitt livsfarliga experiment.

Man kan också jämföra med den svenska modellen under 70-80-talet med en reell inflation på 15% betydligt större än räntan på 10%, som ledde till kollapsen på 90-talet. Men det är nu glömt.

Can Swedish State Bank Really Control Inflation through Repo Rate?

The wise boss of the Swedish State Bank Stefan Ingves believing he is controling inflation by repo rate.

The stated mission of the Swedish State Bank (Riksbanken) is to control the rate of inflation through the repo rate (the lending rate is the rate of interest banks pay when they borrow overnight funds from the Riksbank and is normally 0.75 percentage points higher than the repo rate). The present repo rate is 1% while the inflation is 0%.

The basic idea is that (somehow) the inflation is controlled by the repo rate, that is that the State Bank controls the inflation by turning the repo rate up or down according to the wise decision of the Board of the Bank: If the inflation is too high the repo rate will be increased to bring the inflation down, and if the inflation is too low the repo rate will be decreased to increase the inflation. The repo rate is the cause and the inflation rate is the effect.

But is the description correct? Or is it the other way around: Is the inflation the cause and the repo rate the effect? Of course this is not the view of an activistic State Bank working under the illusion that it controls the economy, but what is the true cause-effect connection between inflation and interest rate?

The idea that the repo rate controls the inflation, is contradictory in the sense that if the inflation is high, increasing the interest rate will increase the cost of money and thus add to inflation. And if the inflation is low, decreasing the interest rate, will decrease the cost of money and thus subtract from inflation.

On the other hand, if you believe that inflation controls interest rate, then increased inflation will demand higher interest rates and vice versa. Inflation and interest rate will thus increase or decrease together, with the inflation being the cause and the interest rate the effect.

In this understanding the State Bank has only a passive role to play by letting the repo rate (controlled by the State Bank) follow the inflation (outside the control of the State Bank).

PS There is a similar tail-wagging-the-dog mix-up of cause-effect in global climate with CO2 alarmists claiming that the trace gas CO2 controls global temperature, while the true physics is that temperature controls CO2, as evidenced in ice cores showing that temperature change precedes CO2 change by about 1000 years.