When Inflation is High, the Fed Aims to Slow the Economy

Why is the Fed increasing rates so aggressively? How does this affect that stock market? How do I beat inflation? When inflation is high, the Fed is likely to raise interest rates in an effort to keep the economy cool. 

Rate hikes slow inflation

As consumers spend more on necessities like food and gasoline, the Fed aims to eventually lower those costs by increasing rates. One huge problem we have is supply-chain issues we have are still rippling through the economy fighting against the Fed's rate increases. If the Fed does not act to curb inflation, the economy may go into recession.

However, it is vital to note that higher interest rates make borrowing more expensive and raise savings account rates (still nominal levels), which help slow the economy. This policy aims to slow the economy while avoiding a recession, or stagflation, which occurs when prices remain high while the economy slows. As such, the Fed is walking a tightrope. To help the economy, the Federal Open Market Committee closely monitors economic data.

What does the Fed do during inflation?

The Fed has the job of keeping inflation under control. Rate hikes are being announced before they happen as the Fed attempts to wrangle inflation under control. Imagine we are on a road and on the left is huge market crash and the right there is untamed inflation. You can't go too far to the left or right and that is what the Fed is attempting to control right now. 

When prices rise rapidly, the Federal Reserve must act to prevent a spiral into inflation. By increasing interest rates, the Fed tries to keep the economy in check by making borrowing more expensive. This has implications for all sectors of the economy, including car financing, lease terms, credit card expenses, and mortgage rates. Inflation can also affect the cost of healthcare, as well as the cost of energy.

What rates are the Fed raising?

As the inflation rate continues to climb, investors are wondering how quickly the Federal Reserve will raise interest rates. With prices rising at an alarming rate, the central bank has a dual mandate: to keep the economy strong while keeping prices stable. It's not surprising that the Fed is trying to balance the two responsibilities. A recent poll found that 69 percent of respondents said that inflation is the most important issue facing the U.S. economy.

When the Federal Reserve decides to raise rates, it does so only when they see that inflation is rising. A faster rate hike may reduce consumer demand, slow economic growth, and raise unemployment, and tank the markets. In other words, it's better to raise rates gradually than to raise them dramatically at once. This is why we don't see a 600-Basis Point increase in rates when the Fed announces hikes. 

How to beat inflation?

1. Negotiate pay every year to beat inflation numbers. 
2. Invest in companies that can increase prices during inflation.
3. Invest in yourself and learn how money works.

Read more about fighting inflation with Dividend Investing here.