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 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.
What is the difference between a recession and inflation? ›
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.
Can inflation start a recession? ›
When inflation increases, central banks raise interest rates to slow the economy with the goal of bringing down inflation. With higher interest rates, the probability of a recession increases, leading to layoffs, fewer jobs, and decreased consumer and corporate spending, among other effects found in a slowing economy.
Do prices go down in a recession? ›
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.
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.
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 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.
Is it possible to have inflation and recession 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.
During an economic downturn, it's crucial to control your spending. Try to avoid taking on new debt you don't need, like a house or car. Look critically at smaller expenses, too — there's no reason to keep paying for things you don't use.
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.
Do cars get cheaper in a recession? ›
If a recession weakens the demand for cars, it may drive prices down slightly, but it won't be a massive decrease in car prices like we saw in 2008 and 2020. If you're thinking about selling, you should decide sooner rather than later.
What happens to CD rates during a recession? ›
Typically, the Federal Reserve will lower interest rates during a recession to spur growth and reduce unemployment. Because CD rates follow the federal funds rate, CD rates will usually go down during a recession.
Should I take my money out of the bank before a recession? ›
You can keep money in a bank account during a recession and it will be safe through FDIC and NCUA deposit insurance.
What is good about a recession? ›
Lower prices — A recession often hits after a long period of sky-high consumer prices. At the onset of a recession, these prices suddenly drop, balancing out previous long inflationary costs. As a result, people on fixed incomes can benefit from new, lower prices, including real estate sales.
Is a recession worse than high inflation? ›
Fullenkamp said a recession is probably the worse of the two. Inflation, which can be driven by high demand, can often be a byproduct of an economy that is still growing, he noted.
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.
When was the last recession in the US? ›
It is considered the most significant downturn since the Great Depression in the 1930s. The term “Great Recession” applies to both the U.S. recession, officially lasting from December 2007 to June 2009, and the ensuing global recession in 2009.
Does a recession cause unemployment? ›
A recession begins, with a decline in total output, a rise in unemployment, and a drop in inflation. The recession hits its bottom, the unemployment rate rises to a maximum, and inflation is at a low point. The economic recovery begins, unemployment begins to fall, and inflation once again begins to rise.
