the policy interest rate is a crude and brute force tool for influencing the economy. The main pathway that it would work in fact is the pavlovian classicall conditioning response – the instinct that businesses can less afford to finance growth – and also the expectations – that everyone expects the economy to contract when rates are hiked, therefore everyone alters their behaviour to be as if the economy is already contracting , and this causes a "self fulfilling prohecy" ie the resultant austere behaviour enforces the contraction that was telegraphed by the rate hike.
BUT , this is just the FIRST reaction. And , it can even be modulated by if the rate hike was expected and not a surprise, as then, economic behaviours would already adjust when the expectations changed.
This first reaction is also emphasised a lot by how the media covers it.
But, then there is the second reaction, second order impacts , and these are when actual economic fundamentals come into play, and this is where Werner's analysis and insight on this matter is greatly valued.
Truly we see historically that central banks trying to steer the economy with interest rates is akin to a child in a car
steering the car with a toy steering wheel.
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