Economy — Inflation — Rates

The Balancing Act of Central Banks: Fighting Inflation vs. Boosting the Economy

Why central banks raised and still raise interest rates to combat inflation, and how this action can affect the economy and your portfolio.

Investiforum
4 min readDec 19, 2022
Photo by Mauricio Santanna on Unsplash

Inflation Matters… Quite a Lot!

Inflation is the increase in the general price level of goods and services in an economy over a period of time. It can be caused by a variety of factors, such as an increase in the cost of production, a decrease in the supply of money, or an increase in demand for goods and services. To combat inflation, central banks can use various tools, such as adjusting interest rates 🚨

Raising interest rates is a common method used by central banks to fight inflation. When interest rates are increased, it becomes more expensive for individuals and businesses to borrow money. This can lead to a decrease in demand for goods and services, as people and businesses are less likely to borrow and spend money on non-essential items. A decrease in demand can help to curb inflation by reducing the overall demand for goods and services in the economy.

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In addition to decreasing demand, raising interest rates can also attract foreign investment 💰 Higher interest rates can offer higher returns on investments, which can attract foreign investors to the domestic market. This influx of foreign capital can help to strengthen the domestic currency and reduce the price of imports. As imports become cheaper, it can help to offset the effects of inflation on domestic prices.

The Downsides of Raising Interest Rates

While raising interest rates can be an effective tool to fight inflation, it can also have negative effects on the economy. Higher interest rates can lead to reduced growth and employment, as businesses may be less willing to invest and hire new employees ⛔ This is why central banks must carefully consider the delicate balance between fighting inflation and maintaining economic growth when deciding to raise interest rates 🤐

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Overall, raising interest rates is considered an effective monetary policy tool to combat inflation, but it must be used with caution to avoid negative consequences on the economy. Central banks must carefully consider the balance between fighting inflation and maintaining economic stability when adjusting interest rates.

And What About my Portfolio?

When interest rates are increased, it can have a significant impact on an your investment portfolio. Higher interest rates can affect the value of different types of investments in various ways.

For example, an increase in interest rates can lead to a decrease in the value of fixed income investments, such as bonds. This is because as interest rates rise, the value of existing bonds with lower interest rates decreases, as investors may prefer to purchase new bonds with higher interest rates. This can lead to capital losses for investors holding bonds in their portfolio.

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On the other hand, higher interest rates can have a positive impact on the value of certain types of investments, such as cash and cash equivalents. As interest rates rise, the return on these types of investments increases, making them more attractive to investors.

Additionally, higher interest rates can affect the value of stocks in different ways. Some industries, such as financial and utilities, may see a decline in stock prices due to the negative impact of higher borrowing costs. However, other industries, such as consumer staples and healthcare, may see an increase in stock prices as investors seek out defensive sectors.

Photo by Diana Polekhina on Unsplash

Overall, the impact of an interest rate hike on your investment portfolio will depend on the specific investments held in the portfolio. It is important to carefully consider the potential impact of higher interest rates on your portfolio and to make any necessary adjustments to your investment strategy.

I’m Raphaël, founder and editor-in-chief of Investiforum.fr, a financial website for French-speaking private investors. Thanks for reading! Don’t hesitate to follow me on Medium, Twitter or Polywork.

This article is for educational and entertainment purposes only and shouldn’t be considered as financial or legal advice. Not all information will be accurate, but all the data is sourced. Consult a professional before making any significant financial decisions. This article shouldn’t be seen as an incentive to buy or sell any of the securities mentioned therein, nor endorsement to any presented strategy. Some links can be affiliated ones.

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Investiforum

Blogger at investiforum.fr (investing for french investors). I talk about investing, financials & money with a long term mindset.