When firms are operating close to capacity, production costs increase and there is less incentive to discount. And when there is strong demand for labour relative to supply, workers tend to seek, and can achieve, larger wage increases. So both the demand-side and the supply-side of the equation matter for inflation, and policies on both sides can affect inflation outcomes.
At the central bank, we work primarily on the demand-side of this equation. Our tool – interest rates – influences the level of aggregate demand in the economy. At any point in time, we take the supply-side of the economy as given, even though, in the long run, successful monetary policy can create conditions that promote investment and the expansion of supply.