Basic Concepts of Recession and Inflation
A recession refers to a period of decline in productive economic activity or GDP. Typically, the economy is considered to be in recession if there is a decline for two consecutive quarters. Recessions are usually accompanied by high unemployment rates, high-interest rates, low production, and low sales. The factors that lead to a recession can be either financial, economic, or psychological. Some of the events that result in a recession are political turmoil, health epidemics, and industrial or authoritarian shifts.
A recession can be managed by the central bank by injecting money supply into the economy, lowering interest rates, reducing tax rates, and increasing government expenditure.
Inflation, on the other hand, refers to a situation in the economy when the prices of commodities and services rise. That eventually leads to a decline in the purchasing power of the general public. This means that one could use a dollar to buy more products in the past than they could today.
There are three primary types of inflation based on the reason behind such inflation. Demand-pull inflation occurs when there is more demand than supply, leading to increased prices. Cost-push inflation occurs when the cost of production rises, and that affects the market price of commodities. In-built inflation is a result of adapting to people’s expectations due to past trends. This means that if the general sentiment is that prices will continue to increase in the future, wages and salaries may have to be increased to match the standard of living.
Similarities between Recession and Inflation
There are some fundamental similarities between recession and inflation that sometimes mistakenly makes the general public substitute one phenomenon for the other. They are alike in the following ways-
At a glance, both these situations lead to adverse economic conditions in a nation. Inflation makes it difficult for households to continue with their normal way of living. Prices increase and non-essential goods are eliminated from people’s budgets. This gradually decreases the standard of living.
A recession, similarly, leads to a limited supply of commodities and services. There is massive unemployment and high levels of uncertainty regarding the near future.
The reasons behind both recession and inflation are similar. An adverse reaction to an unfavorable situation leads to either. For inflation, increased prices of factors of production or decreased supply due to the same could potentially lead to inflationary situations.
For recession, a war or a pandemic may lead to the stopping of normal conditions of production. This leads to decreased supply, people losing their jobs, and a shortage of money supply.
While not every period of inflation needs to be accompanied by a recession, it is possible. A situation where both recession and inflationary indicators are equally present is known as stagflation. The prices keep escalating and the rate of production in the economy keeps decreasing. Not only is there a limited money supply, but there is also limited purchasing power due to high prices.
Differences between Recession and Inflation
Despite the similarities discussed, these two phenomena are completely separate events that have slight differences such as-
Inflation refers to the increase in prices of goods and services in an economy over time. This may be due to low supply or higher costs or even the general perception of the future within the nation.
A recession is the slowing down of economic activities or a drop in the productivity of the nation. This may be due to political unrest or even due to obsolesce technology.
Inflation is measured using the Consumer Price Index (CPI) and Wholesale Price Index (WPI). CPI measures price changes of the commodities in the retail market purchased by general consumers. It measures the prices of both goods and services. It tracks the final stage of inflation. WPI measures the price changes in only goods, and not services, at the wholesale level. It tracks the first stage of inflation.
A recession is measured using the Gross Domestic Product (GDP) of the nation. GDP measures all the factors that consist of the productive aspects of an economy. This includes investment, government expenditure, net exports, and consumption within the nation. A falling rate of GDP is a sure sign of decreasing production.
Inflation occurs continually in an economy. It is a normal part of the progress of a nation. Prices increase but so does the money supply over time. This balances the factors involved in an economy.
A recession is often the result of an unfavorable situation. It is caused due to unexpected or underestimated events. Of course, increasing inflation rates can eventually lead to situations that cause a recession. However, in most cases, recessions are uncommon events and only happen with two consecutive quarters of lack of economic growth.