Are there any (good) alternatives to interest rate hikes to cool inflation?

Résumé détaillé

Mortgage holders reeling from the blunt force of five interest rate hikes this year are questioning if there are other ways of controlling inflation. The answer is not simple.

It is an overused metaphor that monetary policy, the interest rate decisions of Australia's Reserve Bank board, is a "blunt tool" for managing inflationary pressures in our economy.

So, it's only reasonable for mortgage holders, reeling from the blunt force trauma inflicted by five interest rate hikes this year, to ask two main questions: are there any other tools that would be better? Or if adjusting interest rates is the tool we must continue to use, will it work?

But before we peek inside the alternative inflation-fighting tool chest, here's a quick recap of how the interest rate tool actually works.

While the impact of rate hikes on those with big mortgages gets most attention, in fact, higher interest rates work in four main ways to cool price rises. Hurting borrowers is the last way.

First, higher interest rates push up the value of the Australian dollar, which makes imports cheaper. A higher dollar also boosts the incentive for local shoppers to buy foreign goods relative to domestically produced goods or, say, to holiday abroad, slowing demand for domestic companies and making it harder for them to charge higher prices for their products.

Second, higher interest rates discourage spending by increasing the relative attractiveness of saving your money — in a high interest earning savings account, for example — versus spending it (which only works if you have spare money after essentials, of course). It also tends to make it less attractive for businesses to borrow to invest, which tends to cool the economy.

Third, because borrowers can't afford to borrow as much money, this puts downward pressure on the prices of assets like housing, which in turn makes the owners of these assets including mortgage holders, but also those who own their homes outright, feel less rich and less likely to spend.

Finally, and most obviously, of course, higher interest rates directly sap the spending power of households with variable interest rate mortgages.

Overall, higher interest rates…

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