Policymakers are treating inflation like a demand-led symptom of low rates, but the pandemic, climate change and war have made inflation a supply-side problem.

(Originally published Oct. 17 in “What in the World“) While drought in the U.S. Midwest is draining the Mississippi and its tributaries, California seems locked in a perpetual shortage of rainfall. That has drained Lake Shasta—one of the state’s most important reservoirs—to just one-third capacity, threatening Californian agriculture.

Drought and severe storms, combined with port disruptions and war in Ukraine, continue to push food prices higher. Rising food prices, in turn, are one of the major factors in the inflation being fought with interest-rate hikes by central bankers, which are roiling financial markets and hastening a global recession. According to the latest data from the U.S. Bureau of Labor Statistics, U.S. food prices in September were 0.8% higher than in August, contributing to an 11.2% increase in food prices in the past year. While prices for fruits and vegetables posted the biggest increase in September, it was price for grains and cereals that have climbed the most in the past year, rising 16.2%.

Economists may debate whether or not fighting supply-side inflation with interest-rate increases is the wisest course. Ordinarily, higher interest rates are meant to boost the cost of money, lower risk-taking and thereby help cool excessive demand. The fear prior to the pandemic was that years of record-low and even negative interest rates had incentivized risk-taking to the point of creating asset-price bubbles and crowding out worthwhile investments with nonsense (cryptocurrencies and SPACs, just to name a couple).

But if inflation is driven by curbs on supply, such as those created by supply-chain bottlenecks that could be helped by new investment, food shortages that could be alleviated by increased allocations or severe weather brought about by climate change that could be slowed with massive investment in new technology and incentives for sustainable forms of production and consumption, well then boosting the cost of funds could only make matters worse. Conversely, it’s difficult to imagine how higher global interest rates will alleviate drought and the resulting famine gripping Somalia, where the United Nations estimates that two of every five people will require food aid in the next few months.

Unfortunately, starving Somalians aren’t something the U.S. Federal Reserve factors in when it makes policy decisions. And it’s the rising price of the almighty U.S. dollar that’s forcing up rates up everywhere else. For its part, the Fed certainly seems aware of this conundrum, but unwilling to accommodate higher inflation in hopes that the world uses the opportunity to reduce those bottlenecks and invest in sustainability instead of in speculative tomfoolery.

The likely outcome is a vicious circle of commodity-price inflation, in which higher rates only worsen bottlenecks for the creation and distribution of those items for which demand is inelastic. Like energy to some extent; and most particularly for basic foodstuffs.