Why raise rates at all? Why not just tolerate inflation and enjoy higher GDP growth?
In the short run, it is always possible to squeeze out a little extra growth from the economy by jolting it with higher inflation. The acceleration of the CPI from 3% to 7% has certainly had something to do with the remarkable GDP growth that has taken place in 2005 and 2006. However, 7% inflation is harmful, and the effect on GDP growth is short lived. We get higher GDP growth when inflation rises from 3% to 7%, but not if inflation stays at 7%. If another bout of accentuated GDP growth is desired, another jolt of inflation acceleration will be required, going from 7% to 11%. This style of thinking – of obtaining brief increases in GDP growth by having acceleration in inflation – fundamentally destabilises the economy. High inflation is harmful, politically unsustainable, and costly in terms of growth impact when the time comes to restore low inflation. A much better strategy for macroeconomic policy is to devote monetary policy to one task: that of delivering low and predictable infl
