People often use the terms ‘inflation’ and ‘recession’ when discussing a nation’s economy. For every person who is participating in the economy, understanding these concepts helps you to have a better knowledge of the fluctuations happening in the economy.
However, these terms can often seem confusing. Thus, pointing out and learning the differences between them is essential to ward off all doubts. So, let’s bust the myth that you should be an economic expert to know about inflation and recession.
Comparison between Inflation and Recession
| Parameters | Inflation | Recession |
|---|---|---|
| Definition | The rising level of prices over a certain period is called inflation. | The decline in economic activity in a particular region over an extended period is called a recession. |
| Causes | Inflation may occur when demand exceeds supply, prices of raw materials increase, wages of workers rise, devaluation of currency takes place, and money supply rises. | A recession may occur due to unforeseen economic shocks, loss of consumer confidence, falling asset prices, and high inflation. |
| Measurement | The Consumer Price Index is the measure of changing price levels. | The National Bureau of Economic Research analyses different indicators to declare a recession. |
| Negative Impact | Inflation imposes various types of costs on the economy. | Rising unemployment and reduction in income and wages are the serious consequences of a recession. |
| Positive impact | A low level of inflation is helpful to give a boost to economic activity. | There is no significant silver lining in recession. |
Basics Of Inflation And Recession
What Is Inflation?
When you compare the cost of a particular good today to its cost thirty years ago, you will be shocked to see the significant hike. This overall rise in the prices of goods over a period is known as inflation.
Inflation reduces the purchasing power of money. In simple terms, when the overall price level increases, one currency unit purchases fewer goods and services than before. This means that the value of the currency falls.
I/C
Inflation rates in the US over the past ten years
- The inflation rate in 2011 was 3.16%.
- The inflation rate in 2012 was 2.07%.
- The inflation rate in 2013 was 1.46%.
- The inflation rate in 2014 was 1.62%.
- The inflation rate in 2015 was 0.12%.
- The inflation rate in 2016 was 1.26%.
- The inflation rate in 2017 was 2.13%.
- The inflation rate in 2018 was 2.44%.
- The inflation rate in 2019 was 1.81%.
- The inflation rate in 2020 was 1.23%.
- The inflation rate in 2021 was 4.70%.
What Is A recession?
A recession is an economic downturn. It results in diminishing economic activity. This diminishing economic activity during a recession means that the aggregate output falls considerably.
Here, aggregate output is the economic term for the total quantity of goods and services produced in an economy in a particular period.
This decline is reflected in real GDP, real income, and employment. And when it persists for several months, a recession is declared.
I/C
21st-century recessions in the US
- 2001 Recession
Start- March 2001
End- November 2001
Period- 8 months
- 2008 Recession
Start- December 2007
End- June 2009
Period- 1 year and six months
- 2020 Recession
Start- April 2020
End- August 2020
Period- 2 months
Key Differences Between Inflation And Recession
Causes
Inflation– There are different causes of inflation. Following are some of the most significant ones: –
- Rise in demand
The demand for goods can rise due to several reasons like an increase in the supply of money and increased government spending. When aggregate demand exceeds the aggregate supply, the prices of the goods go up.
This type of inflation, known as demand-pull inflation, is very common.
- The Rise in Input Prices
When the prices of the raw materials required for the production of goods increase considerably, then this is reflected in the prices of finished goods.
This type of inflation is referred to as cost-push inflation. It occurs rarely.
Recession– A recession may be due to various reasons. Some of these include: –
- Unforeseen events
Unanticipated economic shocks disrupt supply chains and cause multiple effects on the economy, thus setting the stage for recession.
The covid-19 pandemic is an apt example of the consequences of an economic shock on economic activity.
- Financial market problems
In some cases, recessions occur due to problems in the financial market. The infamous 2008 global economic recession is a case in point.
- High inflation
To control the rising inflation, the central bank may step in and raise interest rates. This rise in the cost of borrowing reduces spending by consumers. It may likely cause an economic slowdown, that is, recession.
Measurement
Inflation- The most well-known measure of inflation is Consumer Price Index (CPI). The Bureau of Labour Statistics is responsible for estimating CPI. CPI shows the change in the overall prices of goods and services.
It is calculated by using a basket of goods and services that represent the aggregate spending by US consumers.
ecession- Although the key indicator of recession is real GDP, the National Bureau of Economic Research that declares recession also looks at the monthly statistics. The other factors that are looked at to determine a recession are employment, retail sales, and measures of income and manufacturing.
Negative Impact
Inflation- Economists have recognized numerous costs of inflation that affect economic variables. Below are some of the important ones: –
- Shoe Leather Costs
High inflation rates encourage people to reduce their money holdings to avoid paying the inflation tax. The costs incurred in terms of time, energy, and other resources to decrease money holdings are known as shoe leather costs.
- Menu Costs
When prices fluctuate frequently, firms have to adjust the prices of their products constantly. Menu costs constitute the expenses of changing the prices and communicating them to the customers by printing new catalogs, advertising, etc.
- Poor allocation of resources
Frequent price changes affect the decisions of consumers by distorting relative prices. As a result, the market forces cannot allocate scarce resources correctly.
- Tax distortions
Many taxes are affected due to inflation. It is because, most of the time, inflation is not considered during the formulation of tax laws. Because of the inflation-induced changes in taxes, people are discouraged from saving.
- Unjustifiable redistribution of money
In cases when there is a high rate of unexpected inflation, it may lead to random redistribution of wealth among people.
Recession- A recession is a horrifying period for the economy and ordinary people. With high unemployment levels, it becomes extremely difficult for people to find work. And those who are already employed constantly face the risk of losing their jobs. Furthermore, the employees may lose certain benefits.
During a recession, the declining aggregate demand causes the sales of businesses to go down considerably. It may force businesses, especially small businesses, into bankruptcy.
Positive Impact
- Inflation- Some economists have asserted that a low level of inflation is good for the economy. The reason is that inflation stimulates spending by people. This increase in spending may give a push to economic activities.
- Recession- There are no positive effects of a recession on the economy.
FAQs (Frequently Asked Questions)
1. What are some of the warning signs of a recession?
It is generally not possible to predict a recession. However, certain indicators may show that a recession is imminent.
The inversion of the yield curve means that long-term interest rates are lower than short-term interest rates, accelerating unemployment, a fall in consumer confidence, and a decrease in the Leading Economic Index (LEI) are some of the significant indicators.
2. What was the reason behind the 2008 recession?
Although there were other contributing causes, the Great Recession of 2008 was primarily caused by the subprime mortgage crisis. Excessive lending led to an accumulation of loans which led to the failure of financial institutions.
3. What is meant by hyperinflation?
Hyperinflation occurs when there is an extremely high inflation level that becomes impossible to control. For example, in September 2008, the inflation rate in Zimbabwe exceeded 389 billion percent
4. Does inflation affect the rich or the poor?
Economists have identified that high inflation rates have a more profound impact on poorer households.
5. What happens to inflation during a recession?
During a recession, economic activity and demand fall. Hence, a fall in the inflation level may be witnessed.
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