In the vast landscape of economic phenomena, two terms often dominate discussions: inflation and recession. While they may seem distinct, their interplay significantly influences global financial dynamics and everyday life. Inflation, the steady rise in the general price of goods, erodes the purchasing power of money, subtly taxing consumers without them always realizing. On the other hand, recessions, marked by sustained economic downturns, can reshape entire industries, employment landscapes, and national economies. Together, understanding these forces provides a lens to interpret past economic events, present challenges, and potential future scenarios.
Inflation can trigger a recession when consumers reduce spending significantly or if the Fed excessively hikes interest rates to control inflation, leading to reduced economic growth and business revenues.
Let’s dig in to each.
Inflation represents a rise in the overall price level in an economy, diminishing the value of money. As a result, the same amount of money fetches fewer goods and services, often called a “hidden tax.”
Causes of Inflation
- Policymakers increasing the money in the economy.
- A decrease in the production of goods and services.
- Increased frequency of money being spent on goods and services.
Impacts from Inflation
- Strain on the economy, consumers, and lenders.
- Reduced real incomes due to prices adjusting faster than wages.
- Borrowers benefit as their fixed debt’s real value drops; lenders face losses.
Inflation can push taxpayers into higher tax brackets, affecting credits, deductions, and exemptions. To counter this, tax provisions are often adjusted for inflation through indexing.
Recession
A recession is characterized by a marked and enduring downturn in economic activity, affecting industries, employment, and consumer confidence. While the technical definition often points to a period of decline lasting more than six months, the real-world implications of a recession can be felt for much longer. This period of economic contraction can be triggered by various factors, from external shocks to internal financial mismanagement. Even when the economy begins to show signs of revival, the aftermath of a recession can linger. Recovery is not just about regaining lost ground; it’s about restoring consumer and investor confidence, rebuilding industries, reinvigorating employment opportunities, and addressing any structural issues that might have contributed to the downturn. As a result, while the recession itself might last a few months, the journey back to robust economic health can span several years, with ripple effects touching almost every facet of society.
What Are Potential Signs of an Impending Recession?
The economy operates in a cycle of peaks and troughs, where economic conditions fluctuate between growth and contraction. These low points in the cycle are not necessarily recessions but become recessions when they are prolonged and serious.
A sustained reduction in Gross National Product (GDP – measures the combined value of goods and services produced by a country’s residents and businesses, regardless of where they are produced. This includes investments made by these residents and businesses, whether they are based domestically or abroad.), increased unemployment, or a decline in stock prices can all signal an impending recession. A recession in the United States is official when the National Bureau of Economic Research (NBER) declares the start—and eventually, end—of one. Their definition of a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
A common time frame used by economists and forecasters is two consecutive months of these conditions.
Historic Recessions
The United States has had a few memorable recessions. In recent memory, there was the two-month recession from the COVID-19 pandemic in early 2020. The memorable “Great Recession” lasted for 18 months from 2007-2009, caused mainly from the housing market crash.
In the beginning of the millennium, the dotcom bubble burst after the longest period of economic expansion in U.S. history and began an eight-month-long recession that ended with action from the Federal Reserve.
The most notable economic downturn in U.S. history, The Great Depression, was actually two particularly bad recessions back-to-back (1929-1933 and 1937-1938). The first was triggered by the Federal Reserve raising interest rates, the stock market crash, and bank failures, and eventually led to fiscal policy expansions such as President Franklin Roosevelt’s New Deal. The second recession was caused by Federal Reserve and Treasury action that contracted the money supply.
U.S. recessions go back to the Panic of 1797—a series of economic constrictions that also impacted Great Britain—and have occurred on a semi-regular basis ever since.
What’s the difference between Inflation and a Recession?
Inflation and recession are vital economic phenomena. While inflation denotes the decrease in the purchasing power of money due to rising prices, a recession represents a substantial decline in the economy over a sustained period. Both can have profound effects on individuals and businesses alike. Policymakers play a pivotal role in shaping these phenomena through their actions, be it increasing the money supply or adjusting interest rates. Understanding the causes, impacts, and historical instances of these events can help in making informed financial decisions and navigating economic uncertainties. Monitoring recent news and economic trends is essential to gauge the current economic climate.
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FAQs
Inflation measures how much prices are rising over time. A recession is a period of negative economic growth. Emergency savings could give you a financial cushion in down markets brought by inflation and recessions. Diversifying your investments could help reduce your risk when inflation is high.
Can you have a recession and inflation at the same time? ›
In economics, stagflation (or recession-inflation) is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high.
What is the difference between a recession and inflation? ›
Inflation and recession are vital economic phenomena. While inflation denotes the decrease in the purchasing power of money due to rising prices, a recession represents a substantial decline in the economy over a sustained period. Both can have profound effects on individuals and businesses alike.
Do prices go down in a recession? ›
Companies need to understand the evolving consumption patterns and fine-tune their strategies accordingly. During recessions, of course, consumers set stricter priorities and reduce their spending. As sales start to drop, businesses typically cut costs, reduce prices, and postpone new investments.
Can inflation start a recession? ›
A recession can also be triggered after an inflationary period. When inflation increases, central banks raise interest rates to slow the economy with the goal of bringing down inflation.
Is a recession worse than high inflation? ›
For households, the principal consequence of a recession is job loss. But as Kashkari noted, the effects of job cuts tend to be more concentrated than the blanket impact of inflation. For someone who does lose their job during a recession, however, the effects can be devastating.
Can inflation be reversed without a recession? ›
A “soft landing” — getting last year's skyrocketing inflation under control without a recession — appears increasingly plausible. All of its structural inequities largely persist, of course, but wages are strong, unemployment is low, and the economy is still growing.
Do interest rates go up in a recession? ›
Interest rates usually fall early in a recession and then rise later as the economy recovers. This means that the adjustable rate for a loan taken out during a recession is likely to rise once the downturn ends. The fixed-rate loan at recession pricing could be a better deal in the long run.
What happens if we go into recession? ›
This usually results in job losses and an increase in the unemployment rate. While there is no single definition of recession, it is generally agreed that a recession occurs when there is a period of reduced output and a significant increase in the unemployment rate.
How to come out of a recession? ›
Build up your emergency fund, pay off your high-interest debt, do what you can to live within your means, diversify your investments, invest for the long term, be honest with yourself about your risk tolerance, and keep an eye on your credit score.
Don't: Take On High-Interest Debt
It's best to avoid racking up high-interest debt during a recession. In fact, the smart move is to slash high-interest debt so you've got more cash on hand. Chances are your highest-interest debt is credit card debt.
Is it better to have cash or property in a recession? ›
Cash. Cash is an important asset when it comes to a recession. After all, if you do end up in a situation where you need to pull from your assets, it helps to have a dedicated emergency fund to fall back on, especially if you experience a layoff.
What happens to your money in the bank during a recession? ›
Your money will not be lost. It is usually transferred to another bank with FDIC insurance, or you'll receive a check. Savings accounts, checking accounts, money market accounts, and CDs are examples of federally insured bank accounts.
What is worse than a recession? ›
The effects of a depression are much more severe, characterized by widespread unemployment and major pauses in economic activity. Recessions can also be more localized, while depressions can have global reach. Stay tuned for a bonus lesson on bogus quotations.
How long will a recession last? ›
ITR Economics is forecasting that a macroeconomic recession will begin in late 2023 and persist throughout 2024. Business leaders recently had to lead their companies through the recession during the COVID-19 pandemic, and some were even in leadership positions back in 2008, during the Great Recession.
How does a recession affect the average person? ›
Increased stress all around. One of the most prevalent ways that recessions affect the average person is simply that stress goes up. It doesn't matter if you're comfortable in your job security and have a hefty financial cushion, or if you're struggling to make ends meet and have $100 in your savings account.
What is an example of a stagflation? ›
For example, if there's a sudden, unexpected increase in the price of a commodity like oil, prices surge accordingly while profits drop. The conflict between increased prices and reduced profits leads to a stagflation situation.
Is a stagflation worse than a recession? ›
Stagflation is considered to be worse than a recession because it is more difficult to remedy. With a recession, a central bank can cut interest rates to stimulate growth, with stagflation, cutting rates would solve the slow growth but worsen the existing inflation.
How to survive stagflation? ›
When stagflation occurs, don't panic, sell your stocks and bonds and invest in rare art, gold, or other unusual commodities. Stagflation is not a good reason to completely abandon a sound investment strategy.
