Inflation vs. Interest Rates

Jul. 20, 2008 4:55 AM ETSPY, QQQ, DIA7 Comments
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Stockerati
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I had a very engaging chat with a colleague earlier this evening. It started when he mentioned that he was planning on buying a new home. To this, I said "Good call on getting it now, as I expect interest rates to go up in the next 6 months". This grabbed his attention and he asked me "Why do you think so?" or something along the same lines.

Lo and behold, this kicked-off a very engaging discussion touching on several things ranging from the economy, inflation, recession, stocks, gold, oil, oil-sands to global warming.

As I drove home from work later, I decided that I’ll cover the core aspect of the chat in this topic, which is, "Inflation and tools to curb it". Simply put, inflation is a rise in prices. Over time, as cost of goods and prices increase, the value of the dollar decreases as you get less with the dollar than what you did a while ago. While the annual rate of inflation has fluctuated greatly over the last half century, ranging from nearly 0% inflation to 23% inflation, the Fed actively tries to maintain a specific rate of inflation, which is usually 3-4% but this often varies depending on circumstances.

Deflation or negative inflation occurs when prices actually decrease over time. Also note that deflation is not the same as disinflation, which happens when the rate of inflation decreases but stays positive (for example, a change from a 4% rate to a 1% rate). Measurement of Inflation: The Feds use two primary mechanisms to measure inflation, which are:

Consumer Price Index or CPI: CPI is a measure of the price of a set of goods and services. This "bundle" contains items such as food, clothing, gasoline, and even computers. The amount of inflation is measured by the change in the cost of the

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Stockerati (http://Stockerati.com/) is an engineer and student of science by training and practice. He's a self-taught investor and has been applying a sense of logic, induction and scientific means to craft out his portfolio and investments for quite some time. He's based in Seattle, WA and has worked for 10+ years in the hi-tech industry. Investing and stocks are his passion, hobby and just like everyone else, he believes in turning this hobby into something very rewarding. Stockerati runs a successful blog at Stockerati.com (http://Stockerati.com/) where he shares his screenings, analysis and view points on stocks, the economy, wall street and international markets regularly. His goal is to be the missing link that investors like him face today. He doesn't day-trade, swing-trade or deal in options or futures. He's very inspired by the principles of value investing but does not have the patience to wait that long for the returns. His singular goal is to make reasonable profits through short to mid-term trades. Stockerati is an exponent of trend investing. Through his proprietary methods he strives to detect early trends through patterns and signals in the market place and applies them to pick his investments. He's been reasonably successful in his endeavors. He believes in complete transparency and shares all his research and conclusions with the world. Stockerati's strategy is around detecting trends early, always staying ahead of the curve and timely entry & exit, while securing great gains.

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