Inflation, Interest Rates, and Stock Market

Connecting the Dots

4 min readJan 8, 2025

Hey everyone,

Today, I want to talk about something that impacts us all (including stock market enthusiasts)— how government decisions on money and interest rates affect the economy, inflation, and ultimately, the stock market.

Let’s break it down, step by step, in plain language.

Note: Views expressed here are personal

What Happened During COVID?

When COVID hit, everything shut down. To keep the economy running, the government and the Reserve Bank of India (RBI) did something simple — they printed money and spent it. This was like giving the economy a painkiller during a crisis.

But there’s a side effect. Printing too much money increases the supply of money in the system. When too much money chases the same goods and services, prices rise. That’s what we call inflation.

Think of a cricket match. If there are only 100 tickets for sale and 500 people want them, the price of those tickets will naturally go up. The same thing happens with money in the economy — too much demand pushes prices up.

What Happened After COVID?

Once the crisis was over, the economy started recovering, but inflation became a problem. To control it, the RBI raised interest rates. This makes borrowing expensive. When people and businesses borrow less, they spend less, and demand slows down.

Imagine you want to buy a car. If the loan interest rate is 5%, you might think, ‘Okay, I can afford this.’ But if the rate goes up to 9%, you might rethink the decision. That’s how higher rates reduce spending.

While this helped reduce inflation a bit, it also slowed down the economy because people were spending and investing less.

Where Are We Now?

Right now, we’re stuck in a tricky spot:

Our economy is slowing down.
Inflation is still high, so prices of essentials haven’t come down much.
Interest rates are neither very high nor very low — they’re somewhere in the middle.
And the stock market is reflecting this uncertainty by moving sideways, with a slight bearish trend.

The big question is: what should the government and RBI do next?

The Dilemma

Here’s the problem. If they lower interest rates to boost growth, inflation could go up even more.

On the other hand, if they keep rates high or raise them further to control inflation, growth could slow down more, and jobs might be at risk.

This is like a tightrope walk — you lean too much on one side, and you fall.

What Can the Government Do?

1. Encourage More Production:
Instead of just focusing on demand, they can work on increasing the supply of goods. For example, by supporting industries with tax breaks or subsidies, businesses can produce more, which helps lower prices.

During onion price spikes, if the government helps farmers store or transport onions better, the supply increases, and prices stabilize.

2. Invest in Infrastructure:
Building more roads, ports, and factories creates jobs and supports long-term growth without directly increasing inflation.

Think about the golden quadrilateral highway project — it boosted transport, trade, and jobs, which helped the economy without making things too expensive.

3. Support Key Sectors:
The RBI can reduce interest rates for specific sectors, like housing or small businesses, instead of cutting rates for everyone.

If housing loans become cheaper, more people might buy homes, which boosts the construction industry without affecting other sectors too much.

4. Fix Supply Issues:
Inflation isn’t always about too much demand. Sometimes it’s because of supply problems. By solving these — for example, ensuring there’s enough electricity or food supply — the government can bring prices down without hurting growth.

What Have Other Countries Done in the Past?

USA (1970s):
They faced a situation called stagflation — high inflation and low growth. To fix it, they raised interest rates a lot, which caused short-term pain (a recession) but stabilized the economy later.
Japan (1990s):
Japan tried lowering rates and boosting spending when their economy slowed. But they didn’t focus on productivity, so their economy remained stuck for years.
India (2013):
When inflation and the rupee fell, the RBI raised rates to stabilize things. At the same time, the government worked on reforms to make industries more productive, which helped the economy recover.

What Could Happen to the Stock Market?

If the government reduces rates too much, inflation might rise, which could scare off investors.
If they raise rates too much, companies might struggle with loans and growth, hurting stock prices.
A balanced approach — focusing on supply-side solutions — might stabilize the market in the long term, even if it’s slow in the short term.

Think of the market like a car. If you press the accelerator (growth) too hard, you risk losing control (inflation). If you hit the brakes (high rates) too much, the car stops moving. The trick is finding the right speed for the road ahead.

As stock market enthusiasts, we need to understand that these macroeconomic decisions don’t just happen in isolation — they directly affect the businesses we invest in. Instead of focusing on short-term moves, keep an eye on how the government balances inflation and growth.

A balanced government strategy might not give the market a quick boost, but it builds a stronger foundation for long-term wealth creation. Remember, investing is a marathon, not a sprint.

Thank you!