Inflation will fall faster if governments also step on the brakes: DNB

Inflation will fall faster if governments cut spending or make services more expensive while central banks raise interest rates. That is the conclusion of a joint study by the Dutch central bank DNB and Radboud University. Conversely, it also works better if central banks and governments move in the same direction.

Central banks are currently raising interest rates due to high inflation. They’re trying to slow down the economy and bring inflation under control. At the same time, governments are trying to absorb consumers’ pain with support measures.

DNB and the European Central Bank (ECB) have warned for some time that governments should only direct such support to people who are really in trouble because of the high prices. Measures like the Netherlands’ energy price cap, which will apply to everyone, will bring more money into the economy and counteract the ECB’s efforts.

The reverse was true after the financial crisis. From 2012, the ECB introduced an accommodative monetary policy. Interest rates fell, and the central bank started buying bonds, which brought more money into circulation. At the same time, most governments in the eurozone focused on austerity, which led to opposing policies. Things got better during the coronavirus crisis when governments and the ECB were both stimulating the economy.