How To Fix Inflation (Beyond Just Raising Interest Rates) (2024)

Key takeaways

• One of the main tools The Fed uses to fix inflation is raising interest rates. This is an example of monetary policy.
• The government can introduce fiscal policies to reduce inflation by increasing taxes or cutting spending.
• The Fed has to be careful about raising interest rates because slowing down the economy can lead to hardship for many people.

The market had its worst day since June 2020 yesterday due to a bad inflation report. Prices all around us are increasing. And as frustrating as it is to hear about it so much, the reality of inflation is that we’re going to keep hearing about it and having to deal with it for some time to come.

Many experts have started to suggest a number of different ways to fix inflation. This leads us to one very important question, how? How do we battle inflation?

Why is inflation so high right now?

Inflation eased slightly to 8.5% in July after hitting a 40-year high of 9.1% in June. Even yesterday’s doom and gloom came after a lower figure, it just happened to be a lower figure that was higher than the marketplace expected. Inflation can be caused by different factors, sometimes related to external current events. However, inflation is generally the result of too much demand and insufficient supply, leading to overall price increases. We’ve had all three of these factors at work lately.

According to experts, high consumer demand in the economy and low supply are driving inflation right now in 2022. When the pandemic restrictions loosened up, the demand for goods skyrocketed while the supply couldn’t keep pace. Supply problems usually come from supply chain issues that disrupt the economy's flow of goods and services, which we certainly had. There’s also the factor of current events, most experts are pointing at the war in Ukraine, which is causing further interruptions to the supply chain and increases in the prices of oil and food.

Who controls inflation?

We know inflation is the consequence of many factors, but it can be controlled by different entities at each stage. The two groups most instrumental in the fight against inflation are The Federal Reserve and the government.

The Fed has a second objective beyond controlling inflation, which is to ensure maximum employment. When inflation increases, The Fed will often raise interest rates in order to make borrowing money more expensive. As you can imagine, such a cooling off of the economy can easily impact the labor market, causing unemployment levels to rise.

It’s a difficult balancing act at the Fed, helping people work without letting price get out of control. When the Fed raises interest rates, they risk hurting the labor market since business revenue may decrease as money costs increase.

The Federal Reserve Chairman Jerome Powell spoke in his most recent public appearance about the importance of battling inflation head-on. Powell knows that the Fed needs to bring inflation down immediately, and the Fed has clarified that the central bank will keep raising interest rates until inflation is under control.

As we look at how to fix inflation, we’ll consider the different types of policies that could be used: monetary and fiscal.

Monetary policy

The Fed using interest rate increases to make lending and investing more expensive is an example of monetary policy.

The Fed misread warnings in the spring of 2021 when it was clear to some that inflation was spreading. The Fed argued that inflation would be transitory and that it resulted from unusual circ*mstances, ranging from supply chain issues related to the abnormal demand that came from the end of the pandemic.

It’s important to note that the central bank can only impact the interest rate. It’s unable to do anything about supply chain issues that cause inflation to rise.

Many economists believe that monetary policy will be restrictive in our volatile economic environment. The policies that Powell and the Fed eventually enact will depend on data from labor reports and the CPI figures.

Fiscal policy

The government can use fiscal policy to fix inflation by increasing taxes or cutting spending. Increasing taxes leads to decreased individual demand and a reduction in the supply of money in the economy. As you can imagine, fiscal policy isn’t very popular because raising taxes is a difficult political move. The last thing that we want to hear when inflation is rising is that our taxes will also increase.

The government could use other fiscal policies to lower inflationary pressures. If Congress were to limit pandemic relief spending and focus on not making the deficit worse, that would assist in reducing inflation.

The obvious new government action to fight inflation is the Inflation Reduction Act of 2022, signed into law by President Joe Biden on August 16, 2022. This new law includes an investment of $369 billion in climate and energy policies, $64 billion to extend the Affordable Care Act to reduce health insurance costs, and a 15% minimum corporate tax that’s aimed at companies that bring in over $1 billion a year. The $437 billion spending package is expected to reduce the deficit by more than $300 billion over a decade.

While skeptics of the law feel, despite its name, the bill won’t have much of an impact on lowering the inflation rate, it is a step in the right direction economically because there’s only so much that the Fed can do on its own.

How long does it take to fight inflation?

The Fed has raised interest rates four times in 2022 because they don’t know how the economy will react to the tightening each time. We have to wait to see the full impact of every rate hike.

What makes this current battle against inflation unique is that the Fed has been criticized for underestimating the impact and the duration of inflation in 2021. The Fed promised transitory inflation, which many analysts doubted. Their reasoning was that prices were going up due to supply chain issues and the quick increase in demand as pandemic restrictions loosened up. For inflation to have been transitory, the supply chain issues would have had to be resolved immediately while supply and demand balanced out as well.

It wasn’t until December 2021 that the Fed stated it was time to retire the term “transitory inflation.” Both Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen had to admit that prices would not stop increasing anytime soon. It became clear that inflation was exceeding the Fed’s 2% goal. With all that being said, the current fight against inflation won’t be quick.

Rate hikes operate with a lag, and the impact may not be felt in the economy immediately. Some industries are more sensitive to interest rate hikes than others. The housing market is strongly connected to interest rates since increased mortgage rates could lead to a slowdown as many folks are simply priced out of the market, unable to afford higher mortgage payments.

Many economists use housing as a leading indicator of what to expect from the economy. Experts track it to ensure that rate hikes merely slow the housing market instead of crashing it completely. There’s still hope that The Fed could provide the economy with a soft landing through these interest rate hikes, narrowly avoiding a recession as the labor market and other economic indicators haven’t tanked yet.

Building an inflation resistant portfolio

Higher inflation means you have to modify your portfolio to ensure that your money’s working for you. The good news is that there are industries that don’t suffer during times of high inflation because they’re essential. There are also ways that you can optimize your portfolio so that you mitigate risks during times of high inflation.

If you’re concerned about how to invest your money during times of high inflation, you may want to take a look at Q.ai’s Inflation Kit to protect your investments. Better still, you can activate Portfolio Protection at any time to protect your gains and reduce your losses, no matter what industries you invest in.

The bottom line

Fixing inflation seems fairly simple in theory, but in application, there are many concerns with going too far and acting too late with both monetary and fiscal policies. An economic slowdown could lead to job loss and pain for many people. This is why fixing inflation requires time and patience. It seems like we’re on the right track to fight inflation, but only time will tell how the economy responds with the fear of a recession hanging over us.

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