When it comes to fighting inflation, interest rates are our weapon of choice. The Fed outlined the basic principles of how raising interest rates will help us lower inflation, but what about the risk involved? How do rate hikes really help fight against price hikes? As always, the experts at Investopedia are happy to clarify this confusing symbiotic relationship.
Interest rates and inflation have a symbiotic relationship. What we mean when we say that is, they will always affect one another. Interest rates are the main way the Fed combats inflation; therefore, interest rates will always travel in the same direction as inflation, albeit at a slower pace.
If inflation is on the rise, so will be interest rates a few months later. It’s the same if inflation is decreasing. Our inflation, due to the pandemic, results in high demand and no supply. Interest rates combat this, by lowering the supply of circulated money in an economy. Less money means less demand to spend money, which leads to lower prices.
The Risk of a Symbiotic Relationship
Interest rates will always be used to fight inflation. And while their relationship is symbiotic, interest rates always lag behind inflation too. Policy is slow on the ball, and inflation can run wild, as we’ve seen.
Additionally, it can be hard for the Fed to anticipate future inflation, as they only have historical data to use to make a prediction. Financial institutions run the risk of increasing inflation by offering too low an interest rate or slowing economic growth by increasing rates too much.
The solution, frustratingly, is to keep our heads down and get through it one step at a time. For example, knowing how inflation and higher interest will affect our day-to-day lives can give us an edge. Plus, being prepared, especially with our taxes, gives us better opportunity to whether this economic storm.
The Council for Retirement Security’s mission is to protect the benefits of every senior citizen. So, in inflated times like these, seniors can still rely on their hard-earned benefits to see them through.