Inflation was a supply shock - but we reached for a sledgehammer anyway
Peter McGahan
Monday 21st September, 2025.
A READER asked me to cover this a few weeks back so - if all you have is a hammer, everything starts to look like a nail. A fly on your new glass table doesn’t need a hammer. And that, give or take, has been the Bank of England’s approach to inflation since 2022.
Your boiler breaks down. Would you try fixing it by turning the thermostat down? That’s effectively what raising interest rates did. It tackled a supply problem with a demand solution. You can guess the results.
The basics: In the UK, banks don’t simply lend out what’s already been deposited. The reality is banks create new money when they lend. This isn’t a fringe idea anymore. The Bank of England said it outright in 2014, confirming what economists like Richard Werner had been arguing for years. The penny dropped: credit creation isn’t constrained in the way we once thought. Loans create deposits, not just the other way around.
Once you realise credit is created out of thin air, the key question becomes: where is that credit going? Is it financing new businesses, sustainable energy, better infrastructure? Or is it pouring into property speculation, driving up house prices and rents while doing little for productive capacity?
Since 2008, regulations added a layer of restraint, nudging banks towards shorter-term and ‘safer’ lending. But if there's profit to be made, banks still lend. And a lot of that lending isn’t doing much for the economy, instead it’s feeding bubbles.
Enter rate hikes.
As inflation rose, sparked by energy shocks, wars, post-Covid factory lockdown supply issues, the Bank of England went to work. Rates rose fast and sharp. But, this kind of inflation wasn’t being driven by us going on shopping sprees or dining out like mental Roman Emperors. It was cost-push inflation (when rising production costs, like wages or energy, force businesses to increase prices, reducing consumers’ purchasing power as opposed to you acting like a Roman Emperor and buying things you don’t need with money you don’t have - credit cards - creating inflation).
Raising interest rates in that context is like cutting back on food because your electricity bill’s gone up.
What rate hikes did do was transfer income - from borrowers to lenders, from the young to the old, from the struggling to the already-OK. If you had a variable-rate mortgage, your monthly payment likely jumped by hundreds. If you rented, chances are your landlord passed on their higher mortgage costs. Meanwhile, banks earned billions more in interest on the reserves they parked at the Bank of England, courtesy of the taxpayer. Smaller companies are hit with wage demands they cannot afford, go bust and the larger liquid companies swoop in. Lovely.
Let’s be balanced. Higher rates do work, eventually. They cool credit-sensitive areas like housing, car finance and business investment. They take the heat out of asset markets. They knock consumer confidence. Over time, inflation did fall from the double digits back towards something resembling the target. So, it would be unfair to say rate hikes were useless. But were they the right tool? That’s the debate.
Mainstream economics treats inflation as a case of too much money chasing too few goods. That’s when rate hikes make sense - when the kettle’s boiling over and you need to take it off the hob. But this wasn’t that. It was a kettle with no water in it - just heat coming from energy prices, corporate mark-ups, and broken global logistics.
Even economists like Joseph Stiglitz pointed out that rate rises in this environment could cause more harm than good. And they were right. You can’t fix a broken supply chain by making mortgages more expensive. But that’s happened.
As wholesale gas prices fell and bottlenecks cleared, inflation eased. The question is: how much of that was down to rates, and how much would have happened anyway?
The result of that approach? Homeowners stretched thin. Renters squeezed harder. Small businesses gasping for air. Meanwhile, energy companies, supermarkets, banks, insurers and holders of government debt saw their returns soar, often bankrolled by the very people struggling to keep the lights on.
This redistribution isn’t a bug in the system, it is the system. Monetary policy always creates winners and losers. But it rarely tells you who they are.
So where does that leave us? With a hard lesson. Inflation born of supply shocks doesn’t respond well to blunt tools. We needed scalpels and spanners, targeted
support for energy costs, incentives for investment, maybe even a rethink of how credit is directed in the economy. Instead, we grabbed the sledgehammer.
Poor fly. Poor table.
If you have a financial query, please call 01872 222422 or if you would like a complimentary inflation guide, please email info@wwfp.net
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
