Interest rate holes in the hull

Can higher interest rates cause higher inflation? Paradoxically, yes.

“Man using a drill to create a hole in the bottom of his boat” created by OpenAI DALL•E 2

Economic lore tells us that the remedy for high inflation is to push up interest rates. Higher rates, economists say, limit lending and pull prices down. But the relationship is more complex than that. Higher rates can create inflation if there’s much debt. Workers demand raises to cover their mortgages. Companies hike prices to maintain profitability. And the government’s increased interest payments create new money.

Jerome Powell, the boss of the Federal Reserve, finds himself trapped between a rock and a hard place. He wants to increase rates to snuff out inflation. But rate hikes are a blunt tool and might even make inflation worse.

First, when rates rise, businesses pay more to borrow. A higher interest bill makes them lift prices to maintain profits. Price increases create inflation and lead to higher rates again. Federal Reserve data from 1955 shows that inflation tends to rise a year after t…