How To Fix Inflation (Beyond Just Raising Interest Rates)

The central theses

  • One of the main tools the Fed uses to fix inflation is by raising interest rates. This is an example of monetary policy.
  • The government can introduce fiscal measures to reduce inflation through tax increases or spending cuts.
  • The Fed needs to be cautious about raising rates because a slowdown in the economy can cause hardship for many people.

The market had its worst day since June 2020 yesterday due to a poor inflation report. Prices are rising all around us. And as frustrating as it is to hear so much about it, the reality of inflation is that we will have to hear about it and deal with it for some time.

Many experts have started to propose a number of different ways to fix inflation. This leads us to a very important question, how? How do we fight 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 decline came after a lower number, it was simply a lower number that was higher than the market was expecting. Inflation can be caused by various factors, sometimes related to external current events. However, inflation is generally the result of excess demand and insufficient supply, leading to general 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. As pandemic restrictions eased, demand for goods skyrocketed while supply failed to keep pace. Supply problems usually arise from supply chain issues disrupting the flow of goods and services to the economy, which we certainly have had. Add to this the factor of current events, with most experts citing the war in Ukraine leading to further disruptions in supply chains and soaring oil and food prices.

Who Controls Inflation?

We know that inflation is the result of many factors, but it can be controlled by different entities at any stage. The two main groups fighting inflation are the Federal Reserve and the government.

The Fed has a second goal in addition to controlling inflation, which is to ensure maximum employment. When inflation rises, the Fed often raises interest rates to make it more expensive to borrow money. As you can imagine, such a slowdown in the economy can easily affect the labor market and lead to an increase in unemployment.

It’s a difficult balancing act for the Fed to help people work without the price spiraling out of control. When the Fed raises interest rates, they risk hurting the job market because corporate earnings can fall as the cost of money rises.

Federal Reserve Chairman Jerome Powell spoke in his recent public appearance about the importance of fighting inflation head-on. Powell knows the Fed must cut inflation immediately, and the Fed has made it clear that the central bank will continue to raise interest rates until inflation is brought under control.

When we look at how to fix inflation, we will consider the different types of measures that could be used: monetary and fiscal.

monetary policy

The fact that the Fed uses interest rate hikes to make borrowing and investments more expensive is an example of monetary policy.

The Fed misread the warnings in spring 2021, when it was clear to some that inflation was spreading. The Fed argued that inflation was temporary and stemmed from unusual circumstances ranging from supply chain issues related to abnormal demand after the pandemic ended.

It is important to note that the central bank can only influence the interest rate. It is unable to do anything about supply chain problems that are causing inflation to rise.

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

fiscal policy

The government can use fiscal policy to fix inflation by raising taxes or cutting spending. Rising taxes lead to lower individual demand and a reduction in the money supply in the economy. As you can imagine, fiscal policy is not very popular as raising taxes is a difficult political move. The last thing we want to hear when inflation goes up is that our taxes will go up too.

The government could use other fiscal measures to lower inflationary pressures. If Congress limited spending on pandemic relief and focused on not making the deficit worse, it would help reduce inflation.

The apparent new government measure to combat inflation is the Anti-Inflation Act of 2022, signed into law by President Joe Biden on August 16, 2022. This new law includes a $369 billion investment in climate and energy policies, $64 billion to expand the Affordable Care Act to reduce health insurance costs, and a minimum 15% corporate tax targeting companies that annually bring in over $1 billion. The $437 billion spending package is expected to reduce the deficit by more than $300 billion over a decade.

While skeptics of the law, despite its name, believe the law won’t have much of an impact in bringing inflation down, economically it’s a step in the right direction, given the limited amount the Fed can do on its own.

How long will it take to fight inflation?

The Fed has hiked rates four times in 2022 because it doesn’t know how the economy will react to the tightening each time. We’ll have to wait to see the full effect of any rate hike.

What makes this current fight against inflation unique is that the Fed has been criticized for underestimating the impact and duration of inflation in 2021. The Fed promised temporary inflation, which many analysts doubted. Their reasoning was that prices rose due to supply chain issues and the rapid increase in demand as a result of the easing of pandemic restrictions. For inflation to have been temporary, supply chain issues would have had to be resolved immediately, while supply and demand would also have been balanced.

It was only in December 2021 that the Fed said it was time to retire the term “transient inflation.” Both Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen admitted that prices would not stop rising anytime soon. It became clear that inflation exceeded the Fed’s 2% target. Despite all this, the current fight against inflation will not be quick.

Rate hikes are delayed and the impact may not be felt in the economy immediately. Some industries are more sensitive to interest rate increases than others. The housing market is strongly linked to interest rates as increased mortgage rates could lead to a slowdown as many people are simply priced out of the market and cannot afford higher mortgage payments.

Many economists use housing construction as a leading indicator of what to expect from the economy. Experts are tracking this to ensure rate hikes are merely slowing the housing market, rather than crashing it entirely. There is still hope that the Fed could use these rate hikes to give the economy a soft landing and narrowly avoid a recession as the job market and other economic indicators are yet to collapse.

Build an inflation-resistant portfolio

Higher inflation means you need to adjust your portfolio to ensure your money is working for you. The good news is that there are industries that don’t suffer in times of high inflation because they are essential. There are also ways you can optimize your portfolio to mitigate risk during periods of high inflation.

If you’re worried about how to invest your money in times of high inflation, take a look at’s Inflation Kit to protect your investments. Better still, you can always turn on portfolio protection to protect your profits and reduce your losses, no matter what industries you invest in.

bottom line

In theory, fixing inflation seems fairly simple, but in practice there are many concerns about going too far and acting too late, in both monetary and fiscal policy. An economic slowdown could result in job loss and pain for many people. Because of this, fixing inflation takes time and patience. It seems we are on track to fight inflation, but only time will tell how the economy reacts to the fears of a recession hanging over us.

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