The European Central Bank raised its base interest rate to 2.5% yesterday. This move is meant to control inflation arising as a consequence of the war between the USA and Iran, as well as food shortages arising from that same war and drought.
No one is suggesting there is excess demand in the Eurozone. However, inflation arising from excess demand, a phenomenon not seen in many economies for decades because so many people are having so many problems in making ends meet, is the only type of inflation that an interest rate rise can address.
When inflation rises instead because of an externally imposed shortage of real resources available in an economy, the resulting inflation is inevitably transitory as people take time to react to higher prices for the goods and services in question, which have the greatest impact when they are for essential items, as fuel and food are. What, however, centuries of history prove is that the transition always happens and price stability returns, but it usually takes a year or so for that process of change to work through the economy. This, though, is far less time than it takes for a change in interest rates to have an impact on inflation, if it ever does.
For these reasons, increasing interest rates at this moment might be described as an act of economic illiteracy. It might also be described as class warfare based on economic aggression, because its purpose is, in reality, to deter those on wage income from seeking pay increases to maintain their economic positions, while those who profit from the price increases are left to enjoy their newfound and unearned riches.
A metaphor might help here. What we are seeing is akin to a household suffering a reduced water supply because the pipe from the water main to the house is partially blocked or, more likely, leaking. The household is under stress, and the response from the water company is to increase the price of the water, rather than solve the leak or unblock the pipe in question.
The water company is now happy. Its loss of revenue and profits, resulting from the reduced supply to the household, has been addressed. The price increase restores its well-being. However, nothing has been done to solve the household's problem.
Now imagine the European Central Bank as the equivalent of the water company. It is increasing the price of money to maintain the position of the owners of wealth at this moment, without in any way addressing the problems that the economy, or most people in it, are facing. The Bank of England will do exactly the same thing, very soon.
The required economic and political policy at this moment is very different, and threefold.
First, demand should be made that Trump and Israel stop their war. They are not just causing untold harm in the Gulf region; they are also exporting it around the world. The inflation Europe and we are facing is of their creation. That should be made very clear.
Secondly, essential action has to be taken to ensure alternative energy and food supplies since shortages of both are the cause of the inflation. Such supplies may be possible over time and with investment, but will be very much harder to deliver if interest rates are increased. The interest rate increase is, therefore, likely to be entirely unproductive because it provides no incentive for the problem to be solved.
Third, the current inflation has to be allowed to work through the system, whilst reassurance is provided that deliberate, interventionist action by the government in the economy will resolve the supply problems that are creating it.
What we need, in other words, is a government that is in control of its central bank, which understands that meeting need is its priority, that action is its obligation, and that preserving the interests of those with wealth is not an issue that needs to concern it when people are in need. We have the exact opposite, and that is going to make this winter very difficult if, as I expect, the Bank of England copies the action of the European Central Bank.
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It has long been said that the Collective Noun for a group of Bankers is a “Wunch”. They are really doing their best to earn that accolade now.
Your Water Company analogy is an excellent one. It is simple but so appropriate and, in a curious way, hints at the lunacy of the household budget analogy that so many have bought into. An infographic perhaps? On another note, we are led to believe that the economy “grew” by 0.4% last month but on what is that dubious figure based? It does not seem to accord with day to day experience. And what are the chances that, in a few weeks time, it will be quietly downgraded?
OK, I am on the case…
As for GDP, I think this will just be another ONS error. There are so many precedents.
The water company analogy is also apt as isn’t this the proposed solution by Ofwat for future supply issues, to increase the cost to the consumer rather than fix leaks or build new reservoirs? They truly are taking the proverbial.
Hello Richard.
At first I was wondering if a long-term reduced supply, especially of necessities like food or oil, into an economy with the same demand as before, could be construed as ‘excess demand’. Therefore, a central bank changing interest rates could also be construed as the correct policy option.
However, further into your post, you mention the time it takes for interest rate changes to take effect, by which time the external shock shall have passed through, or become the new normal in the economy. So, central banks increasing interest rates doesn’t make sense.
I was then thinking, firstly, that it was good that an answer to my question appeared further into the post, and secondly, that it’s easy to see an overlap with your video today on revolution.
Also, there’s an overlap with the stuff you said about ‘silos’ a while ago. Countries in silos, institutions in silos, companies in silos, societies in silos…and eventually individuals in silos. Metaphorically.
I feel you (and others) provide solutions, to prevent society ending up with the wolves at the doors, but the wolves shall end up at the doors nevertheless, and the people behind the doors shall complain, that no one tried to stop the wolves ending up at the doors.
Except I have…
Bt, thank you
Yes, class warfare indeed.
When reading the excellent “Fatal Shore” by Robert Hughes (1986), a
when he commented on the many reasons for transportation of so many people to Australia in the 19th century, if I recall correctly, he describes the ruling elite of that time as ‘mismanaging’ the economy- so in effect nothing much has changed, they are still just as murderous and blood thirsty. I feel fortunate that I am no longer young enough to be called up for military service as across the west, they seek to drive us to war with Russia/Iran/’some evil group’ as a distraction from what you rightly call “class warfare”.
And don’t get me started on the uniformed thugs…. etc etc
“First, demand should be made that Trump and Israel stop their war.”
If EU govs were interested in the economic well being of their citizens (based on their actions/lack thereof, they don’t give a shit) then there is one group of very simple non-violent actions that the EU & UK could take:
1. ALL Israeli embassies closed and all Israelis expelled from the EU/UK
2. ALL commerce with Israel stops immediately.
3. No flights to/from Israel.
4. All Israeli aircraft banned from EU/UK airspace.
5. The Straits of Gibraltar are closed to any shipping heading to Israel.
& make it clear that this will last at least 5 years after which it will be reviewed.
None of this will happen, because Israel & its supporters are well embedded in EU & UK political processes.
But if it did, the Israeli gov now committing genocide would collapse, overnight. Cost to EU & UK – zero.
tRump? huff puff and do nowt.
We are already getting to the point where Miliband’s sanctions look to be wholly inappropriately meagre.
The ECB by my understanding is a wholly (intellectually) owned subsidiary of the Bundesbank (motto: Old-Nazis-R-us ). The interest rate rise has an immediate consequence.
EU energy strategy: 1: max energy independence via renewables 2: max electrification.
Main variable influencing renewables costs? WACC – weighted average cost of capital. Renewable reality: most projects have a 80/20 debt/equity profile. Higher interest rates = more costly elec.
The ECB/old nazis claim that by raising interests rates they are “fighting inflation” (gee is that like “fighting for peace & f..king for virginity?”) – but raising interest rates makes a key EU policy more difficult & expensive,……….. for Euro serfs.
It is clear the ECB (& the bundesnazis) don’t give a stuff about EU citizens in general and German citizens in particular (Zvart punt& all that).
I wonder how citizens’ reaction to this is working out on the ground in e.g. Germany?……..oh look National Socialism with a different name is back & supported by lots of people. The Sunday election was 5 days ago – but the ECB (& by extension the Bundesnazis) has yet to appreciate the political consequences of raising interest rates just to meet an arbitrary figure. Ah well, I guess they will learn, the easy way, or the very very hard way.
[…] explained why I thought this a form of class warfare in a blog post I wrote last week, and there will be videos to come around money, inflation, and interest rates on Thursday and […]