| From a theory pov, inflation can be cost push (raw materials cost more for producers) or demand pull (demand more than available supply). In the real world - both can happen simultaneously. When interest rates rise, not only does higher cost of borrowing discourage investments and spending (an attempt to kill demand to bring down prices) it also reduces the money supply of the economy. The money supply refers to all the liquid assets and cash that are in circulation in a country's economy. It is important because it is closely related to the credit market. But money supply works in conjunction with market risk - which often branches out to two functions - liquidity preference and risk premium. The former is a theory that suggests that an investor might prefer 6% over 10 years than 3% over 5 years. The latter suggests that one investor might pick the 3% (lower yield) option because it has better risk premium - say the 6% is a bond in a DVD store, and the 3% is a government bond (example). What we're witnessing now is the spiralling, second order effects of rising rates - which on the one hand attempt to kill demand and curb prices for consumer goods, but on the other, affect the money supply and force investors to rebalance their portfolio and start evaluating different risk premiums. The Fed has dug itself into a hole because monetary policy changes have massive spillover effects into other areas of the economy, not just inflation and cost of borrowing, but also things like how participants in the economy view liquidity and risk premiums. Can't A/B test monetary policy, or life. Institutions, like people, will learn to face the consequences of their actions and learn to live with their choices. |