We present a new diffuse interface model for the dynamics of inextensible vesicles in a viscous fluid with inertial forces. A new feature of this work is the implementation of the local inextensibility condition in the diffuse interface context. Local inextensibility is enforced by using a local Lagrange multiplier, which provides the necessary tension force at the interface. We introduce a new equation for the local Lagrange multiplier whose solution essentially provides a harmonic extension of the multiplier off the interface while maintaining the local inextensibility constraint near the interface. We also develop a local relaxation scheme that dynamically corrects local stretching/compression errors thereby preventing their accumulation. Asymptotic analysis is presented that shows that our new system converges to a relaxed version of the inextensible sharp interface model. This is also verified numerically. To solve the equations, we use an adaptive finite element method with implicit coupling between the Navier–Stokes and the diffuse interface inextensibility equations. Numerical simulations of a single vesicle in a shear flow at different Reynolds numbers demonstrate that errors in enforcing local inextensibility may accumulate and lead to large differences in the dynamics in the tumbling regime and smaller differences in the inclination angle of vesicles in the tank-treading regime. The local relaxation algorithm is shown to prevent the accumulation of stretching and compression errors very effectively. Simulations of two vesicles in an extensional flow show that local inextensibility plays an important role when vesicles are in close proximity by inhibiting fluid drainage in the near contact region.