Conflicts of Objectives and Interest rates.

Readers Question: If central bank wants high interest rate to contain inflation, but low interest rates to help exporters then what are the policy instruments available at the same time? If interest rate is the only policy instrument, then would one objective has to be sacrificed for the other?

If the Central bank increased interest rates to reduce inflation, the higher interest rates would cause an appreciation in the pound. This is because the higher rates would attract hot money flows increasing demand for holding sterling. The higher value of the pound would harm exporters because exports would become more expensive.

If the government / Central Bank wished to reduce inflation without causing an appreciation in Sterling, they could use deflationary fiscal policy (higher taxes and lower spending). This would slow economic growth and reduce inflation without causing an appreciation in sterling. It would reduce government borrowing though would be quite unpopular. The government could also implement supply side policies to try improve competitiveness of exports but, at best these would take a long time.

If you just use interest rates, then there is inevitably some conflict between different objectives.

Earlier this year, the main conflict was between inflation and economic growth. The MPC didn’t want to cut interest rates because inflation was above target, but, this high interest rate contributed to a sharp economic slowdown.