Understanding inflation and interest rates: A guide for savers
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Key takeaways
Moderate inflation is normal, but high inflation increases living costs and may weaken savings.
Raising interest rates can slow inflation, while lowering them can stimulate spending.
High-yield savings, certificates of deposit, and money market accounts can help to protect against inflation.
Inflation measures the rate at which the prices of goods and services increase over time, eroding purchasing power. The Federal Reserve manages inflation by adjusting interest rates. When inflation rises, central banks typically raise interest rates to cool consumer demand, which simultaneously drives up interest yields on savings products like high-yield savings accounts and certificates of deposit (CDs).
Inflation and interest rates are two of the most influential economic forces affecting everyday finances. While high inflation reduces the purchasing power of your money, the Federal Reserve’s response — adjusting benchmark interest rates — directly impacts the return you can earn on your savings. Understanding how these economic forces interact helps you choose the right financial products to preserve your hard-earned cash and mitigate inflation.
Looking to protect your savings from inflation? The Raisin marketplace allows you to find, fund, and manage competitive high-yield savings products from a nationwide network of top-performing banks and credit unions through a single secure login.
What is inflation?
Inflation is the steady increase in the general price level of goods and services over a period of time. As inflation rises, each dollar buys a smaller percentage of a good or service, effectively lowering consumer purchasing power. Economists track inflation to gauge economic health and cost-of-living changes.
Inflation is the rate at which the general level of prices for goods and services rises over time, reducing the purchasing power of money. Inflation is a primary economic indicator influenced by broad consumer demand, supply chain conditions, and government fiscal policy.
Moderate inflation is typical within a growing economy. However, rapid inflation increases living costs and erodes the real value of cash savings.
Inflation: A persistent rise in price levels that decreases what your cash can purchase.
Deflation: A decline in general price levels, which increases purchasing power but often signals economic stagnation.
What causes inflation?
Inflation is primarily caused by an imbalance between supply and demand. This happens when consumer demand for goods outpaces what the market can supply. Economists generally break this down into three main categories: rising demand, increasing production costs, and higher wage expectations.
While several factors influence price fluctuations, inflation fundamentally stems from supply and demand imbalances. When consumer demand for goods and services outpaces available supply at current prices, businesses tend to raise prices to manage demand, driving overall inflation upward.
Economists generally categorize the root drivers of inflation into three key categories:
Demand-pull inflation: Occurs when consumer demand exceeds available supply across the economy, prompting businesses to raise prices. Triggers include increased government spending, rising employment wages, or elevated consumer confidence.
Cost-push inflation: Occurs when production costs, such as raw materials, labor, or supply chain logistics, increase. Businesses often pass these higher operating expenses down to consumers through increased retail prices.
Built-in inflation: Driven by worker and business expectations that past inflation will continue. Workers demand higher wages to maintain their living standard, and businesses raise prices to cover higher labor costs, creating a self-reinforcing economic cycle.
How the Federal Reserve manages inflation
The Federal Reserve manages inflation by adjusting the federal funds rate. Raising interest rates makes borrowing more expensive, which slows economic spending and lowers inflation pressures. Lowering rates makes borrowing cheaper, stimulating economic activity when growth or inflation is too low.
Central banks, such as the Federal Reserve, manage inflation by adjusting monetary policy tools, primarily the federal funds rate, to maintain economic stability. As a result, market interest rates and inflation rates frequently trend in the same direction over time.
Congress established the Federal Reserve's "dual mandate" through the Federal Reserve Act, directing the central bank to pursue two main goals: maximum employment and stable prices.
When managing this dual mandate, the Fed adjusts rates according to economic conditions:
When inflation is too high: The Fed raises interest rates to increase borrowing costs, cool consumer demand, and slow economic activity.
When inflation or growth is too low: The Fed lowers interest rates to reduce borrowing costs, encouraging consumer spending and business investment.
How inflation is measured
The Federal Reserve measures inflation primarily using two indexes: the Consumer Price Index (CPI), published by the Bureau of Labor Statistics, and the Personal Consumption Expenditures (PCE) Price Index, published by the Bureau of Economic Analysis. The PCE index is the Fed's preferred benchmark.
To guide monetary policy decisions, the Federal Reserve closely monitors key economic indexes that track price changes across different sectors of the US economy.
Consumer Price Index (CPI): Published monthly by the Bureau of Labor Statistics (BLS), the CPI measures average price changes paid by urban consumers for a fixed market basket of goods and services, including housing, food, transport, and healthcare.
Personal Consumption Expenditures (PCE) Price Index: Published by the Bureau of Economic Analysis (BEA), the PCE index measures broad household expenditures. It serves as the Fed's primary gauge of inflation because it adjusts for consumer substitution behavior, such as buying lower-cost alternatives when prices rise.
Core Inflation Indexes: Both CPI and PCE feature "core" variations that exclude volatile food and energy components, offering policymakers a clearer picture of long-term underlying inflation trends.
Why the Fed targets a 2% inflation rate
The Federal Reserve aims for a 2% long-run inflation target rather than 0% to prevent deflationary cycles and maintain labor market flexibility. A modest, predictable level of inflation supports steady economic growth while giving the Fed room to lower rates during recessions.
While 0% inflation might sound ideal, central banks avoid targeting zero inflation. Economists recognize two primary benefits to maintaining a low, predictable rate of positive inflation:
Deflation prevention: Positive inflation creates a safety buffer against deflation, an economic environment where falling prices can cause consumers to delay purchases, triggering economic contraction and job losses.
Monetary policy flexibility: Moderate inflation allows nominal interest rates to remain slightly higher during normal economic periods, giving central banks room to cut rates to stimulate the economy during downturns.
The Federal Open Market Committee (FOMC) formally set a long-term PCE inflation objective of 2%. This target is widely viewed as optimal for maintaining high employment and stable economic growth.
How inflation and interest rates affect your savings
Inflation reduces the real purchasing power of savings if the yield earned on the funds is lower than the annual rate of inflation. When interest rates rise in response to high inflation, savers can earn higher annual percentage yields (APYs) on deposit products to help offset inflation loss.
The real value of cash depends on the gap between your earning rate (APY) and the rate of inflation. If savings earn an interest rate lower than current inflation, the purchasing power of that cash declines over time.
Understanding real rate of return
If a savings account offers a 2.00% APY during a period of 4.00% annual inflation, the account balance increases numerically, but its real purchasing power declines by approximately 2.00% over the year. Choosing savings products with competitive yields helps minimize purchasing power loss.
Simplify your savings strategy with Raisin
Navigating changing interest rate cycles does not require managing multiple logins across different financial institutions. The Raisin platform provides access to high-yield savings accounts, money market deposit accounts, and certificates of deposit from a nationwide network of 100+ FDIC- and NCUA-insured partner banks and credit unions — all accessible through one free account and a single secure login.
Take action on your financial goals
Ready to make your money work harder in today's rate environment? Open a free Raisin account today to browse competitive savings products from trusted banks and credit unions.
The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
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*APY means Annual Percentage Yield. APY is accurate as of October 13, 2026. Interest rate and APY may change after initial deposit depending on the terms of the specific product selected. Minimum opening deposit is $1.00.
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