Inflation has reached 7%, well above the 2% target. Part of it comes from a spending boom and part from higher import prices. Compare three responses.
Raise interest rates
- Savers: Earn more interest, protecting the value of savings.
- Borrowers: Pay more on loans and cut spending.
- Inflation: Cools the spending boom, easing demand-pull inflation.
Higher rates cut demand-pull inflation but can raise unemployment and do little about import prices.
Let the currency rise
- Consumers: Imported goods become cheaper.
- Exporters: Lose sales as their goods become dearer abroad.
- Inflation: Directly reduces imported cost-push inflation.
A stronger currency targets import prices, at a cost to exporters.
Cut government spending
- Government: Budget position improves.
- Public services: Fewer services or delayed projects.
- Inflation: Lower total demand eases demand-pull pressure.
Contractionary fiscal policy cools demand but reduces public services and may slow growth.