Every month the BofE raises the interest rate bit by bit, knowing inflation is so high and knowing they had to raise the rates quite high, why do it so slowly?
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They don’t want to drive the economy into a recession. In effect, the Fed plays a “signaling” game. By indicating that it will continue to fight inflation, it sets the expectation that inflation will not increase and this can be a self fulfilling prophecy.
A sudden and steep rise in interest rate can trigger asset price collapses and business failures due to lack of liquidity. This would be a very last resort for the Central Bank.
Short answer: rasing interest rates has its own costs to the economy, and significant jumps carry much higher costs, so they only want to do it by the absolute mimimum they need to.
given the Economy is an almost incomprehensibly complex machine of feedback loops and confidence games, its basically impossible to accurately predict the amount they need to jump to ahead of time. Ergo, the make smaller, more mesured inceases, which give people time to adjust to each raise and can better see how much they need to go.
Imagine you’re on the highway and traffic suddenly clears up. You’re going 5 mph under the speed limit so you decide to accelerate.
Do you floor the gas pedal or do you gently increase the throttle until you reach the speed limit and then let up to maintain speed?
It’s the same sort of deal, only infinitely more complicated. They have to do it slowly because big movements *cause* big movements and it’s not always going to do what they want it to do. Economics isn’t an exact science, they can’t just plug the Global Economy into a spreadsheet and have it spit out a number they need to change the interest rate to in order to reach a desired Local Economy goal.
Because they don’t know what the “correct” level to raise to is exactly and overdoing it is much worse than being a little late. So they raise bit by bit and look at how the economy reacts until they get the desired result.
The Fed raising interest rates is them pumping the brakes. You wouldn’t want them stomping on the brake’s every time a little inflation pops up. Doing it slowly lets them react to conditions as they develop.
The rate changes are an art, and not a science, and going “too much” even once has worse consequences than sneaking up slowly on the correct answer.
They could do a large jump and then you’d be here complaining about the impact and ELI5 “why did they do this??”.
Firstly, interest rates aren’t the only thing impacting inflatiron. Why the focus on rates? Supply.chain challenges, to consumer behavior, to fiscal budgets to trade agreements all have an impact here. Expecting rates to be a one and done solution is nonsense.
Secondly, rates impact the economy first and foremost. Inflation is impacted as a by-product. To build off of this, you’d be giving households little time to adjust to higher rates on their mortgages. How are normal people supposed to just eat an extra $500 per month cost over night?
In addition to the other answers, there’s an element of pragmatic humility to it; if you’re wrong, the downsides of the fuckups are more contained, and the gentler increases better allow folks to study the effects before making additional choices.
I think the much more interesting question would be why interest rates are raised in the first place, given the fact that the evidence for interest rate hikes curing inflation is quite thin and even central bankers themselves admitting that it doesn’t actually work that well.
Fed doesn’t wanna smash economy like Hulk! They play mind games, keep inflation in check. No recession, please! 😄🏦💥
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