We hear the terms recession and inflation in economic discussions all the time. But, do we truly know the difference and how they affect our life? We know that neither of these processes benefits economic progress by any means. However, their causes and effects are entirely different.
In today’s article, we will talk about:
- What is inflation?
- What is a recession?
- Comparison between inflation vs recession.
- What are the similarities and discrepancies between inflation and recession?
- How can you be financially stable in a period of economic uncertainty?
Keep reading this article to get the answers!
What Is Inflation?
Inflation is a rise in the price of products and services over time in an economy. As a result, every currency is weakening due to lesser purchases of goods and services.
Inflation mainly appears for two reasons: when there is an increase in production costs (like raw materials and wages) and when demand rises, so consumers are willing to pay more for the product, which leads to a price increase.
Economists believe that moderate inflation is beneficial for an economy. The inflation rate of about 2% is considered stable and standard.
However, the inflation rate sometimes significantly increases, leading to high inflation. It also indicates an overheated economy.
Currently, in the United States, consumer prices are 8.3% higher than in the past year.
In our developed world, we use more commodities than ever before. So the price rise is in everything we use – food, grains, metal, fuel, utilities such as electricity and transportation, and services like health care, entertainment, and labor. Inflation intends to calculate the overall impact of price changes for all products and services we use.
Inflation influences everyone somehow, especially people with fixed incomes like pensioners. Still, if (or when) inflation gets out of control, everyone is affected.
When the prices rise consequentially, we can buy fewer goods and services with the same amount of money. So, it directly impacts the cost of living for the common public, which further implies a deceleration in economic growth.
Most economists state that sustained inflation appears when the economic growth falls behind a nation’s money supply growth.
Economists and policymakers measure the inflation rate using the Consumer Price Index (CPI). According to the Bureau of Labor Statistics, the CPI is a ”tool used for calculating the average change over time in the prices consumers pay for a market basket of consumer goods and services”. In other words, when the CPI sees positive growth – we face inflation.
It’s evident that inflation isn’t a positive effect. To fight against it, the monetary authority (such as central banks) takes specific actions to manage the money supply and credit to keep inflation at an optimal level and keep the economy running without problems.
In contrast to inflation, deflation indicates a general price decline when the inflation rate drops below 0%. Be careful not to confuse deflation with disinflation. Disinflation is a term that refers to a slow down in the positive rate of inflation.
What Causes Inflation?
The root causes of inflation are an increase in the supply of money. It can be done through various mechanisms in the economy. The following are the usual ways how the monetary authorities raise a country’s money supply:
- They loan new money into existence as reserve account credits through the banking system by buying government bonds from banks on the secondary market. This is the most common method.
- They print and give away more cash to citizens.
- They legally reduce the value of the legal tender currency.
The money is losing its purchasing power in all of these situations. There are three broad types of inflation: demand-pull inflation, cost-push inflation, and built-in inflation.
Advantages of Inflation
- People who possess tangible assets (property or stocked commodities can benefit from inflation because it raises the price of their assets, and they can sell at a higher rate.
- Businesses in risky projects and individuals who invest in company stocks often speculate about inflation because they expect better returns than inflation.
- A standard inflation rate is usually promoted to encourage spending over saving. In a period of higher inflation, there is a greater incentive to spend now instead of saving and spending later due to money power falling. Because people spend more cash, it can positively affect economic activities in a country. It is considered a balanced approach to keep the inflation value in an optimum range.
Disadvantages of Inflation
- Inflation doesn’t make buyers happy. They have to shell out more cash for the same amount of goods and services as before. Also, inflation erodes the assets valued in their home currency, like cash or bonds. So, the people who hold these assets can have challenging times. However, there are other ways to invest during inflation.
- Higher costs can be imposed due to high and variable inflation rates. Because of rising prices, businesses, workers, and consumers must account for the effects in their selling, buying, and planning decisions. As a result, we have more uncertainty in the economy.
- Inflation has many adverse effects on an economy. One of the most significant is that it distorts relative prices, wages, and rates of return along with its own price increase. A feedback loop where things just get worse over time! Austrian economists believe this process to be a significant driver for cycles in economic prosperity, which they call “invisible installment loans.”
What Is a Recession?
A recession is a significant, widespread, and overall decrease in economic activities. It usually lasts for six months or more, and one of the most popular rules of thumb is that two consecutive quarters of decline in a country’s Gross Domestic Product (GDP) constitute a recession. Still, a recession is a standard part of an economic cycle.
A recession is described as a time of high unemployment rate, a fall in the price of assets, and decreasing cost of commodities that cause low consumer confidence in the economy. Economists often characterize a recession as an economic decrease starting at the peak of the growth that preceded it and ending at the low point of the consequent downturn.
Other professionals believe that a recession occurs when the GDP growth rate is negative after the second quarter. Still, others point out that a recession can begin before quarterly gross domestic product reports are out.
The National Bureau of Economic Research (NBER) is the national source for measuring the degree of the business cycle. The NBER is in charge of determining whether the country is in a recession. The NBER uses monthly data to regulate when a peak or trough has occurred.
The real GDP is the crucial indicator of a recession. The real refers to the effects of inflation stripped out, which measures everything businesses and individuals in the US produce.
We have an example of the consumer price index in action in the late 1920s and 1930s – the period of the Great Depression. The weakening economy caused a general downward trend in the prices. In that period, prices dropped, unemployment increased, and wage growth slowed.
All of that led to decreased household consumption and sales fall as well. It was a classic situation of the recession causing deflation.
For example, fiscal policy can help reduce the pain of a recession. But, a fiscal policy intended to alleviate inflation’s impact on consumers only worsens inflation.
Sometimes the real GDP growth rate first turns negative; it can signify recession. But, sometimes, progress will be negative and then turn positive in the following quarter.
In addition, the NBER might revise the GDP estimate in its next report. Thus it’s challenging to regulate if there is a recession based only on GDP.
Unlike inflation, a recession gives savers the rare opportunity to invest in safer securities. It involves Treasuries with more beneficial interest rates.
Here is a list of signs to make sure that the economy is in a recession:
- High levels of unemployment: The employment rate and real income tell the commissioners about the overall situation of the economy.
- Real Gross Domestic Product: The NBER checks monthly estimates of GDP.
- Real income: When real income decreases, it’s the same with consumer purchases and demand.
- Manufacturing: The commissioners look at the manufacturing sector’s health, as measured by the Industrial Production Report.
- A fall in housing prices and sales
- Post-war slowdowns
- Bursting of bubbles
Governments usually adopt macroeconomic policies to try to save the situation. It involves decreasing taxation and increasing government spending and the money supply.
It’s not strange that many professionals think that recession is worse than inflation. Especially during the COVID-19 pandemic, we experienced job losses three times larger than in the Great Recession of 2007-2009.
Comparison Between Inflation vs Recession
A recession indicates an overall drop in economic activity, consequently in a decline in the Gross Domestic Product for two consecutive quarters and is measured by it. Contrary, inflation implies an increase in the price of goods and services over a period in an economy.
You should also understand the difference between recession and stagflation. Stagflation is a combination of slow growth and inflation. However, stagflation is much rarer. A lengthy time of stagflation occurred in the U.S. during the 1970s.
On the executive schedule, the macroeconomic outlook is still dominant. When demand overshot and supply chains sputtered last year, many companies discovered pricing power they weren’t aware of.
However, the Fed’s actions to battle against inflation have increased the recession fears are beginning to mount. Current macroeconomic worries are rotating out of inflation and towards another downturn. The idea that a recession would help with inflation is persuasive but far from guaranteed.
The Fed must decide how much front-loading of policy it wants to keep inflation expectations anchored. They will try to escape the scene of the double dip recession from the early 1980s. Their primary and very blunt instrument is interest rate hikes.
Similarities
The correlation between recession and inflation is that both affect economic activities. In addition, both are processes as a result of unfavorable economic outcomes.
We don’t need an economics course to understand the correlation between inflation and the likelihood of a recession. It’s because price variations disturb demand, leading to inequality in goods and slowing economic activity.
As Joseph Gagnon, a former director on the Federal Reserve Board and a senior fellow at the Peterson Institute for International Economics, said: ”Inflation feels very bad because your money is worth less, while a recession feels very bad because the economy is creating fewer jobs.”
A former Federal Reserve board director has a good point – neither is constructive.
Differences
Definition
Inflation is an increase in the price of products and services over time in an economy. A recession is a significant decline in economic activity and is officially described as two consecutive quarters of negative economic growth.
Measure
Inflation is measured by the Wholesale Price Index and the Consumer Price Index, shown in percentage. A recession is measured by Gross Domestic Product.
Period
Inflation ensures an ongoing basis in an economy. A recession appears only in certain economic conditions.
How to Be Financially Stable in a Period of Economic Uncertainty?
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Final Thoughts
Which one is worse, inflation or recession? There is no final answer; neither is enjoyable but in different ways.
We hope this article helped you better understand inflation and recession. Most importantly, we hope you don’t seem so scared of either one! It’s customary in the economic cycle to experience high inflation and recession. The crucial thing you can do is take care of your financial situation and do the best you can.
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