By making use of a dynamic model, this paper examines the effectiveness of the interest rate policy to control inflation. The model utilized in this paper considers both demand and supply side effects of interest rate. These effects are used to derive the relevant impulse response functions and welfare loss to the society associated with supply side shocks. The paper compares three policies to control inflation; (i) monetary policy with commitment, (ii) Taylor’s rule, and (iii) inflation targeting. These policies are distinguished based on their ability to control inflation and minimization of the overall welfare loss to the society. We argue that in the presence of a cost channel it is imperative that interest rate policy should be used with restraint.