How does the U.S. combat inflation?
The Federal Reserve’s primary tool for controlling inflation is interest rates.
When inflation runs too hot, the Fed raises rates to slow borrowing and spending. Higher rates make loans more expensive, cool consumer demand, and reduce the money flowing through the economy. The Fed can also sell assets from its balance sheet to further tighten financial conditions.
These actions don’t work instantly, which is why inflation often lags policy decisions by many months.
How does inflation affect stocks?
Different companies are affected by inflation in different ways. If a company can raise prices without significantly affecting demand, inflation could lead to higher corporate profits.
On the other hand, if rising prices result in a decline in demand for a company's product, or make producing a product more expensive, a high rate of inflation could be a negative catalyst for a stock.
Some companies can directly make more money from inflation, such as banks. Think of it this way: As prices rise, customers take out larger loans for purchases. Larger loan balances equal more interest income. Plus, since inflation is typically accompanied by rising interest rates, banks tend to generate more net interest income as a result of inflationary environments.
Having said all that, inflation is a generally negative catalyst for the stock market. Inflation tends to cause consumer spending to drop, and investors have less cash available to invest in the stock market due to the need to spend an increasing percentage of their income on everyday expenses.
Why inflation matters so much to investors
The biggest takeaway is simple: cash loses value over time.
Savings accounts, CDs, and money market funds may feel safe, but historically they struggle to keep up with inflation, especially after taxes. Stocks, bonds, and real estate have been far more effective at preserving and growing purchasing power over the long run.
You don’t need complex strategies to combat inflation. Broad index funds and diversified portfolios have done the job for decades. The real risk isn’t short-term market swings -- it’s letting inflation quietly eat away at money that never gets invested.
