Inflation picked up again in September, bringing renewed attention to whether the Federal Reserve can really control rising prices.
The Fed raised its benchmark interest-rate range by a quarter percentage point in September, bringing it to 3.75%–4%, then held rates steady in October as it continued to assess the economy and inflation.
Those decisions tie directly into our latest Food for Thought presentation, where we discussed how the Fed influences inflation, why its tools have limitations, and what that means for your financial plan.
Our recent WJNotes article, The Most Important Price in the World Keeps Rising, explored rising interest rates and the opportunities they can create for investors. In the Food for Thought presentation, we took a step back to explain what the Fed can accomplish by changing rates.
Who Is the Fed?
The Federal Reserve is the central bank of the United States. One way to think of it is as a bank for banks. Banks hold accounts there, and the Fed helps support a stable financial system. Unlike a commercial bank, its purpose is to support the economy rather than maximize profits.
What Does Lower Inflation Mean?
One important distinction is that lower inflation doesn’t mean lower prices. When inflation falls, prices generally continue rising, just at a slower pace.
Imagine something costing $100. After a year of 8% inflation, it costs $108. If inflation slows to 4% the following year, the price still increases, reaching $112.32.
That helps explain why hearing that inflation has improved may not feel reassuring at the grocery store. Prices are still higher, and they are still rising. The Fed generally aims for inflation around 2%, rather than trying to return prices to where they were several years ago.
How Interest Rates Help
The Fed tries to keep prices stable while supporting a healthy job market. Interest rates are one of its main tools.
Consider buying a $40,000 vehicle. Financing it at 3% feels different from financing it at 8%. At the higher rate, you might buy something less expensive, postpone the purchase, or keep your current vehicle longer.
Businesses make similar decisions about buying equipment or expanding. When enough households and businesses pull back, spending slows, giving sellers less room to raise prices.
Those changes take time, which creates another challenge for the Fed.
During the presentation, we compared monetary policy to adjusting your thermostat. Lowering the setting does not cool your house immediately. Keep lowering it before earlier adjustments take effect, and you could eventually make the house too cold.
The Fed faces a similar challenge when deciding whether it has done enough.
Where the Fed’s Influence Ends
We also discussed why the cause of inflation matters.
If people are buying more than businesses can supply, higher rates can help slow demand. But if gasoline prices rise because oil supplies are disrupted, higher rates cannot create more oil.
The same goes for shipping problems and other supply disruptions. The Fed can influence spending, but it cannot directly resolve every problem pushing prices higher.
Bringing It Back to Your Financial Plan
Even modest inflation adds up. A lifestyle costing $100,000 annually today would require about $149,000 in 20 years at 2% inflation, or $219,000 at 4%.
At WJ Interests, we account for that uncertainty by evaluating different potential investment outcomes and future spending needs. We also consider when you will need the money. Savings for an upcoming purchase serve a different purpose than investments for retirement decades away.
The central takeaway was that the Fed has considerable influence, but it cannot precisely control inflation. We build and revisit financial plans with that uncertainty in mind, so your goals do not depend on correctly guessing their next move.
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PAST PERFORMANCE IS NOT A GUARANTEE OF CURRENT OR FUTURE RESULTS. Examples of historical information included in this presentation do not, nor are they intended to, constitute a promise of similar future results. Specific client portfolio allocations, risks and returns can and may deviate from these examples depending on accounts and types of investments available through each account. Future market views by WJ Interests, LLC may vary significantly from the historical examples presented herein and no one receiving this summary should assume that WJ Interests, LLC will be able to replicate successful views in the future.