Are interest rate rises a very blunt tool when dealing with inflation ?

Rabidlamb

This is something that I wondered about for sometime when it comes to controlling a societies spending.

So rather than have the Jones' overheating the economy with their spendthrift lifestyle we take it off them at source by upping their mortgage payments.
Ok, so they can't enjoy their weekend break every month & the hotels stop gouging us due to reduced demand.
But not everyone has a mortgage so it's not a catch all device.
Surely it would make more sense to up VAT at times of inflation & reduce it when in a deflationary cycle.

What am I missing here ?.

SBWife

You're missing at least two other ways an interest rate increase effects inflationary pressures:

Interest rate increases also normally increase the propensity to save. eg. Smith has no mortgage or other floating rate debt so his outgoings are unaffected by the change in interest rates but the increase in interest means he earns more on his savings so instead of heading out to the dogs on Friday night he saves the money in the CU.

Interest rates are also an input into most business decision making, as they increase projects that previously had a positive net present value may turn negative and thus be rejected. This also cools the economy.

silverharp

SBWife wrote: »

Interest rates are also an input into most business decision making, as they increase projects that previously had a positive net present value may turn negative and thus be rejected. This also cools the economy.

its normally too late at this stage as the small town thats just completing its 5th speculative hotel venture is already is overbuilt by 4. The managed rate only works within a small range of activity. If you look at the last decade real interest rates were negetive during the boom (junk spreads also drop) and become positive during the bust. What the central bank does with interest rates now is just window dressing.


As for OP's point, higher taxes during the good times would only work if it was used to pay down debt. Very few countries ever do this and more likely would just allow the government to create more inflation by switching rivate spending to public spending.

TiGeR KiNgS

VAT can only be introduced once a year through government.
VAT impacts directly on prices, (effects competition from abroad)
Taxation would cease to be Efficient, Simple and Fair (the mantra of all democratic tax systems as set out by Adam Smith in the Wealth of Nations)
And above all, people would never accept it, Our way of life is built on competition and the market economy. Your way would dramatically affect this.

Basically, there are too many reasons why VAT (and other taxation) is a horrible alternative to effect the demand curve.