- What is inflation?
- How does inflation impact recession?
- What does this mean for small business owners?
Q: Is inflation the same as recession?
A: No, inflation and recession are two different concepts – although they may be related to one another. For example, high rates of inflation can contribute to or cause a recession. In turn, a recession can lead to inflation as the government desperately attempts to print more money and “kick the can down the road.”
No one can seem to agree whether the United States is currently in a recession or not.
If you ask White House officials and their loyal followers, they’ll tell you that our economy is nowhere near a recession. They might point to positive job numbers, a robust stock market, and a general sense of optimism.
On the other hand, there are those who are very skeptical of the “official story.” These experts point out that the United States has already seen two consecutive quarters of negative GDP growth.
This was the technical definition of a recession – at least before Wikipedia scrambled to edit the definition in lockstep with the U.S. government’s excuses.
So are we in a recession? Or are we merely approaching a recession?
In the end, these arbitrary labels don’t really matter.
The most important thing is to react to what’s really going on in the economy. If you ignore all the buzz and hype, you can cut straight down to the facts and survive the next few years.
Whether you believe we are in a recession or not, there’s one thing no one can deny:
We are seeing insane levels of inflation.
But what is the relationship between inflation vs recession? Are they two sides of the same coin? Does inflation lead to recession, or vice versa?
If you understand this complex relationship, it may be easier to take advantage of incredible opportunities within the next few years.
As Forbes reports, there are two types of people who get rich during recessions: the rich and the lucky.
Understand the complex relationship between inflation vs recession, and you might just be one of the lucky few.
- What is inflation?
- How does inflation impact recession?
- What does this mean for small business owners?
What is inflation?
Inflation is simply an increase in prices.
When the economy inflates, the purchasing power of each dollar within that economy decreases. This means that the cost of living (and everything else) becomes more expensive.
Inflation has a negative connotation in today’s world, but in many ways, inflation is just a reality of life. For example, a candy bar that only costed a few cents back in 1922 could cost up to five dollars today. No one expects us to return to 1922 prices.
It is only when inflation gets out of control that it becomes a problem.
Today’s inflation numbers are calculated with the Consumer Price Index (CPI) and Wholesale Price Index (WPI). You’ll also hear mention of a “basket of goods” when the government discusses inflation.
The problem is that these calculation methods are extremely vulnerable to manipulation. For example, the government can swap items out of the “basket of goods” so that inflation seems much lower than it actually is.
If bacon becomes too expensive, they can replace it with eggs in the “basket of goods.” If eggs become too expensive, they can replace it with ham.
Commentators such as Peter Schiff have also pointed out that our methods for calculating inflation are not the same as the methods used back in the 1980s. Schiff argues that if we were using the same calculation methods today, inflation would be at an all-time high.
What causes inflation?
The real question is what causes inflation.
Experts divide inflation into three categories:
- Demand-Pull Inflation: This type of inflation occurs when the economy’s production capacity cannot keep up with the increase in the money supply. In other words, there are more dollars chasing fewer goods. The age-old laws of supply and demand ensure prices rise as a result.
- Cost-Push Inflation: When the cost of raw materials and labor increases, the finished products created with those raw materials also increase. If it costs more to make something, the consumer will pay higher prices. The “supply” part of the equation decreases, while demand stays the same or even grows.
- Built-In Inflation: This type of inflation occurs simply because people expect prices to rise steadily over time. If people predict that their cost of living will rise, they will ask for higher wages. This in turn makes it more expensive for products to create goods and services, creating a “wage-price spiral.”
For the most part, inflation today has been caused by unrestrained money printing by the Federal Reserve and central banks across the world. In order to pay for things like government programs (or more recently, aid to Ukraine), governments have simply increased the money supply.
It’s important to understand that inflation disproportionately affects lower-income people, as these individuals are more likely to be living paycheck to paycheck. While a wealthy individual can shrug off a higher grocery bill, this slight increase in prices can bankrupt a poor family.
Many refer to inflation as the “invisible tax” – and for good reason.
In order to pay for programs and international aid, governments could simply raise taxes. However, higher tax rates are never popular – so they tax their citizens in a different way by simply printing money and increasing the cost of living.
The elusive definition of recession
To understand the “inflation vs recession” debate, you also need to know the definition of a recession.
But this definition has become a surprisingly controversial subject as of late.
Before 2022, almost everyone agreed that the technical definition of a recession was two consecutive quarters of negative GDP growth.
However, when the American economy actually experienced this in 2022, the White House and various journalists scrambled to redefine the term “recession.”
Watching this play out in real time was surreal, and Wikipedia even quietly altered its definition of recession in lockstep with the White House.
When faced with this problem, the White House claimed that the American economy couldn’t possibly be in a recession because of strong job numbers.
They also vaguely stated that there were “many factors to consider” when defining a recession, and left it at that.
It’s worth mentioning that these “strong job numbers” might not be as encouraging as they seem, since many of the jobs that were “created” by the current administration were simply people returning to work after the pandemic.
For all intents and purposes, it’s easier to go with the “classic definition” of a recession – which means that the U.S. is already in the midst of one.
Inflation vs recession definition
When examining the relationship between inflation vs recession, you might be asking yourself:
“What is the difference between inflation vs recession?”
In simple terms, inflation can cause a recession, but inflation alone isn’t the same thing as a recession.
“Recession” is a term used to describe economic downturn, which may or may not involve inflation.
Inflation vs recession vs depression
Now let’s add one more important term to the mix:
Depression.
A depression is the exacerbated version of a recession. If a recession lasts for more than three years, it becomes a depression.
Depressions are also associated with a number of additional factors, including:
- Reduction in global trade
- A 10% reduction in annual GDP
- Sharp decline in construction
- Widespread unemployment
- Impacts many countries
Inflation vs recession vs stagflation
Now for the final addition to the inflation vs recession debate:
Stagflation.
As of this writing, the U.S. economy may be experiencing high levels of inflation, but it still boasts solid employment. Growth is also continuing.
But what happens if we get inflation and unemployment at the same time?
You guessed it:
We would get stagflation.
This is worse than normal inflation, and it would be an extremely bad sign for the U.S. economy if we spiraled into stagflation.
Stagflation is associated with several factors, including:
- Less construction of new homes
- Rising mortgage rates
- Job losses
- Less consumer spending
How does inflation impact recession?
Now that you understand a few key terms in the inflation vs recession debate, it’s time to learn about the relationship between these two concepts.
Perhaps most obviously, inflation can cause a recession.
When the cost of living rises to a certain level, consumers simply stop buying as many things. For some, this is a matter of choice. For others, it is a matter of necessity.
Our current economy is built on the availability of cheap money. Consumers are willing to go into debt in order to buy the things they want – whether it’s a gadget from Amazon or a family home.
When prices get too high, people can no longer afford to make these purchases – especially when their wages are staying the same.
When people only purchase and spend money on basic necessities like food and rent, businesses begin to fail.
If you’re running a business that thrives only when consumers have an excess of cash ready to spend, a recession can pose a serious challenge. It might even lead to bankruptcy.
When these businesses fail, people start to lose their jobs.
Suddenly, the economy isn’t just struggling with inflation – it has entered into a period of recession.
Inflation can also increase the cost of raw materials, which can push an economy towards recession.
A solid example of this is the housing market.
If building materials are cheap, the construction industry experiences growth. If raw materials like lumber and concrete become more expensive, construction will slow. This also results in lower employment levels as construction workers are laid off.
And why build homes if no one is going to be able to afford them when they’re complete?
The same general logic applies to the automotive industry and virtually any manufacturing business. If it costs a lot to make something, businesses will cut expenses by firing individuals and increasing the price of their finished goods.
Faced with high prices, consumers become much more cautious in their spending habits, with many choosing to save their money instead of spending it or investing it.
Fortunately, this is exactly what the economy needs to fight inflation. With less spending and more saving, there are lower levels of stimulation in the market. This leads to lower inflation and eventual price stabilization – at least in theory.
This is the textbook example of the relationship of inflation vs recession.
But as many investors will tell you, the market can behave in extremely unpredictable ways – and the economy doesn’t always follow the examples laid out in economics textbooks.
Inflation doesn’t always lead to recessions. For example, the rate of inflation could be manageable to the point where wages increase at the same general rate. This means that a consumer’s spending power is not affected, and economic growth can continue.
In addition, a recession doesn’t always lead to a reduction in inflation. Stagflation is a clear example of this.
Things start to get really volatile when the government decides to print money to fight a recession, digging their hole deeper and deeper.
Instead of allowing a recession to take place and accepting that the economy needs to “correct itself,” nations may try to increase money supply in a misguided attempt to stimulate the economy.
But this has led to serious problems in history. A key example is Zimbabwe, which experienced “hyperinflation” starting in 2007.
In 2020, it was reported that the nation had reached an annual inflation rate of 737%, which has since made $100 billion banknotes more common. It’s important to note that Zimbabwe started printing money after it had already entered serious economic hardship.
Inflation vs recession: Which is worse?
Most experts agree that inflation is worse than a recession because inflation affects everyone, whereas a recession may only lead to job losses in certain sectors.
However, it all depends on your specific circumstances. If you hold assets like real estate or commodities, an inflationary period can be extremely lucrative.
If you’re saving up for a down payment on your first home, inflation can make this goal seem impossible as housing becomes increasingly expensive.
In contrast, a recession may cause temporary hardship and a few years of economic shock, but eventually it can lead to price stabilization and a more “normal” rate of inflation.
But try telling that to someone who has just lost their job.
Again, inflation or recessions affect different people in different ways – and it all depends on your unique circumstances.
What does this mean for small business owners?
Business owners can create different plans for periods of inflation vs recession, meaning:
Regardless of what the economic situation is, you need a “Plan B.”
If it looks like we’re about to head into a recession, think about what people tend to buy during these times.
Will your company be successful even when consumers reign in their spending? Or do you offer products and services that people only buy when times are good?
If you fall into the latter camp, consider diversifying. Offer budget-friendly alternatives to your “flagship” products.
Diversification is one of the best ways to remain recession-proof, whether you’re a small business owner or an amateur investor.
Another effective strategy is to cut costs as much as possible without firing your most talented team members.
This might be easier than you think, especially when you consider options like Alliance Virtual Offices.
A virtual office allows you to cut all of the costs associated with a traditional office lease.
You can run your business from home and allow your employees to work remotely. Alliance Virtual Offices also offers additional services such as mail forward and Live Receptionists, further supplementing your new remote work system.
How to make the most of the “inflation vs recession” relationship
Recession-proof strategies are within your grasp.
While the inflation vs recession debate is interesting, sometimes you need to stop philosophizing and actually take action.
Options like virtual offices and diversification can make a real difference as we head towards a reputation.
It’s still not too late to recession-proof your business.
Reach out to Alliance Virtual Offices today to get started with an effective action plan.
Further reading
