Inflation was not caused by people spending too much. So why will higher interest rates work?
In the past, we’ve sometimes raised interest rates when the UK’s economy was growing very fast. In those times, we were concerned that booming economy would lead to higher inflation.
The causes of today’s inflation are different. One of the main causes was the sharp rise in the cost of energy and some food products that was caused by Russia’s invasion of Ukraine.
And just before that, there was also a surge in demand for products after the Covid lockdowns came to an end. Businesses had problems meeting that sudden demand.
Higher interest rates can’t stop the impact of these kinds of things. But they can slow down new causes of inflation that follow on from these shocks.
These new causes include things like businesses putting up their prices because they face higher costs themselves.
But if their customers have to cut back on spending, then businesses have to start offering more competitive prices to keep their customers.
The cost of food, heating and other bills have gone up more quickly over the last year than for many years. These things are essentials. People in the UK didn’t cause inflation because they spent too much on them.
But the way we get inflation down is just the same as if the economy was booming. Higher interest rates will reduce overall spending in the UK.