Raising interest rates to fight inflation can actually make prices go up.

The Takeaway

We’re taught that the only way to kill inflation is to 'cool the economy' by making borrowing expensive. This paper looks at the 1970s and finds that aggressive credit crunches actually forced companies to hike prices just to survive. By choking off the money firms needed to operate, the government accidentally reduced the supply of goods, which drove prices even higher. This creates a 'stagflation' trap where the cure for inflation is actually the cause of it. For us, it means the Federal Reserve's favorite tool might be a double-edged sword that cuts the wrong way.