Recession and inflation relationship

Inflation and Recession | Economics Help

recession and inflation relationship

In economics, stagflation, a portmanteau of stagnation and inflation, is a situation in which the late s, inflation and recession were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. The only good thing about a recession is that it cures inflation. The Federal Reserve must always balance between slowing the economy. Before looking at this chart of the relationship between Inflation and recession you might think that as inflation rises costs would be getting.

In particular, an adverse shock to aggregate supply, such as an increase in oil prices, can give rise to stagflation.

  • Inflation and Recession
  • Recession And Inflation

Other factors may also cause supply problems, for example, social and political conditions such as policy changes, acts of war, extremely restrictive government control of production. In technical terms, this results in contraction or negative shift in an economy's aggregate supply curve. The resource shortage may be a real physical shortage or a relative scarcity due to factors such as taxes or bad monetary policy which have affected the "cost" or availability of raw materials.

This is consistent with the cost-push inflation factors in neo-Keynesian theory above. The way this plays out is that after supply shock occurs, the economy will first try to maintain momentum — that is, consumers and businesses will begin paying higher prices in order to maintain their level of demand.

What is Inflation?

The central bank may exacerbate this by increasing the money supply, by lowering interest rates for example, in an effort to combat a recession. The increased money supply props up the demand for goods and services, though demand would normally drop during a recession.

recession and inflation relationship

However, during a supply shock i. So, inflation jumps and output drops, producing stagflation. Nixon Shock Following Richard Nixon 's imposition of wage and price controls on 15 Augustan initial wave of cost-push shocks in commodities were blamed for causing spiraling prices.

The price controls resulted in shortages at the point of purchase, causing, for example, queues of consumers at fuelling stations and increased production costs for industry.

Stagflation

Neoclassical views[ edit ] A purely neoclassical view of the macroeconomy rejects the idea that monetary policy can have real effects. Nominal factors like changes in the money supply only affect nominal variables like inflation. The neoclassical idea that nominal factors cannot have real effects is often called " monetary neutrality " [23] or also the " classical dichotomy ". Since the neoclassical viewpoint says that real phenomena like unemployment are essentially unrelated to nominal phenomena like inflation, a neoclassical economist would offer two separate explanations for 'stagnation' and 'inflation'.

Neoclassical explanations of stagnation low growth and high unemployment include inefficient government regulations or high benefits for the unemployed that give people less incentive to look for jobs.

Stagflation - Wikipedia

Another neoclassical explanation of stagnation is given by real business cycle theoryin which any decrease in labour productivity makes it efficient to work less. The main neoclassical explanation of inflation is very simple: The nominal factors that determine inflation affect the aggregate demand curve only.

Thus the main explanation for stagflation under a classical view of the economy is simply policy errors that affect both inflation and the labour market. Ironically, a very clear argument in favour of the classical explanation of stagflation was provided by Keynes himself. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

recession and inflation relationship

By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.

If a man is compelled to exchange the fruits of his labours for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbours as a favour, or relax his efforts in producing it.

A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the waste and inefficiency of barter.

In other words, was a recession caused by cost-push factors. Duringthere was a double dip-recession with low economic growth, but rising inflation. This was because Impact of depreciation in value of Pound. Fall in the value of pound increased the cost of imports which feeds into inflation A rise in oil and hence petrol prices. A rise in taxes. The rise in spare capacity was less than expected.

inflation and recession relationship | The Money Enigma

Helped by zero interest rates, there were fewer insolvencies than in previous years. Also, the rise in unemployment is less than in previous years Firms have sought to maintain good cash flow by not cutting prices. Deflation and the Great Depression In the Great Depression, there was large fall in output, and this caused deflation. Prices fell quite significantly. The reason the Great Depression let to deflation was Fall in money supply due to banking crisis in the US Fiscal austerity.

What’s the deal with recession and inflation?

UK government pursued austerity in — cutting unemployment benefits and raising taxes. Global slump caused global fall in commodities and manufactured goods.

The Pound was overvalued in the Gold Standard.