By Mathew Carr*
A reminder that there’s a central paradox of modern central banking: using monetary policy to combat supply-side and geopolitical shocks is like using a hammer to fix a plumbing leak.
When services inflation is driven by rising fuel prices, commercial utility bills, transport logistics, and higher employer statutory costs, raising the Bank of England base rate does not drill a single drop of oil, resolve regional conflicts, or unclog global supply routes.
The Economic Mismatch: Why Rates Don’t Fix Supply Shocks
External / War Shock ──> Higher Energy & Transport ──> Rising Service Overheads
│
Central Bank Response ──> Higher Interest Rates ───────────────┘ (Squeezes domestic demand)
- The Inability to Target Root Causes Interest rates only control domestic demand and credit creation. If a restaurant’s prices rise because its electricity bill doubled and delivery freight is 6.6% higher, raising mortgage payments across the country does zero to lower that restaurant’s energy or freight tariffs.
- The “Second-Round Effects” Rationale The Bank of England’s internal logic is not that rate hikes will lower energy prices, but that rate hikes will suppress domestic demand enough to stop those costs from spreading. By making borrowing expensive and draining household disposable income, the BoE tries to ensure that:
- Consumers stop buying if businesses raise prices further.
- Businesses are forced to absorb higher input costs into their own margins rather than passing them on.
- Workers cannot successfully demand wages that match price increases.
- Tool Mismatch vs. Systemic “Con” Calling it a “con” highlights a real structural flaw in how central bank mandates function. The BoE is legally required to hit a 2.0% CPI target, regardless of whether inflation is caused by domestic overspending or global geopolitics.
Because interest rates are the only lever the Monetary Policy Committee possesses, they pull it to depress the domestic economy until total demand drops enough to force inflation numbers down—even if the underlying cause was an external supply shock all along.
The Trade-Off
Squeezing domestic households and small businesses to absorb global energy and trade disruptions shifts the economic burden of external shocks entirely onto domestic borrowers. It highlights the limit of monetary policy: interest rates can cool an overheated economy, but they cannot manufacture supply.
*With Gemini