No matter where you are in the world -- in the U.S. or abroad -- many consumers are feeling the strain when it comes to money. Unfortunately for many of us, most things are just more expensive than they were before. Whether it's food at the grocery store, gas or transportation prices, or something else. This raises the question: Is it inflation? A recession? Or is it a combination of the two?
While you may hear both of these terms, it's important to distinguish between what constitutes a recession and what is simply inflation.
Keep reading to understand more about the distinctions between the two.
The Definition of Inflation
In simple terms, inflation occurs when the prices of goods and services rise. This might be difficult for customers because the same amount of money does not go as far as it did before. When prices are rising in an inflationary environment, your earnings or salary may not be rising in order to keep pace. Which means your money is worth less than it was before.
The current situation that most of us are feeling right now is indeed inflation. The Consumer Price Index (CPI), which tracks the price of specific products and services over time, is the most often used indicator of inflation. The CPI is reported by the Bureau of Labor Statistics and is defined as follows:
“The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas.”
According to the BLS's most recent CPI report, consumer prices climbed by 9.1% on average over the previous year, from June 2021 to June 2022. This is the largest single-year increase since the period ending in November 1981.
So, if your grocery spend is higher than it used to be, you're not alone, and it's not all in your head. Things are definitely more expensive right now.
What Are the Causes of Inflation?
Inflation often happens over a long period of time, which means it can be tough to pinpoint its exact cause. But there are three typical causes for inflation: demand-pull, cost-push, and built-in.
Here’s how each one works -- along with simple examples.
When demand for a good or service is too high to keep up with production, the value of that good or service increases.
For example, let’s say Olivia Rodrigo debuts a new “driver’s license” phone case at a red carpet event. Fans rush to buy the same phone case online, to the point where it becomes very difficult to find any more of these cases, as stock is limited. At this point, the price of the phone case would increase substantially due to high demand and low stock.
When production costs rise, so too does the cost of the product (or service).
Imagine you help your daughter run a chocolate chip cookie stand each summer. Normally, the cost of the ingredients is $5, which allows her to serve 20 customers. She charges each customer $1 for a cookie, giving her a profit of $15. But this year, the cost of her ingredients has increased to $10. In order to make the same profit -- or higher -- your daughter would need to increase the price of the cookies.
Sometimes, as a response to inflation, salaries and wages rise as well. When more money is in the economy, the producers of goods and services may raise their prices with the knowledge that their customers are able to pay the higher price. (Keep this in mind: The conditions in a built-in inflation environment usually start with either demand-pull or cost-push inflation.)
For example, let’s say you work for a company that has an employee cafeteria. The CEO announces that all employees will receive a raise at the beginning of the year. Knowing this, the cafeteria decides to raise its lunch prices, reasoning that all the employees are now making more money and will be able to pay the higher price. Employees may then demand a higher wage, and the cycle may continue.
While these examples are simple, they can help show on a smaller scale how these types of inflation may function on a macroeconomic level.
The Definition of a Recession
Recessions are something that no one likes to think about. And when inflation is high, you may be concerned that a recession is on the way -- or that one is already underway. The truth is, however, that recessions and inflation are not always related.
A recession occurs when your country's economy is not performing well. Economic activity is down, unemployment is high, and the stock market may be moving in the wrong direction. But it’s not easy to find a consensus definition of what a recession is.
A common rule of thumb is that a recession is defined by a country’s Gross Domestic Product, or GDP decreasing for at least two consecutive fiscal quarters. But economic experts often feel this is too simplistic to determine whether a recession is truly happening.
Many economists point to a combination of other factors to determine whether a recession could be coming. For example, even if the U.S. GDP falls for a second consecutive quarter in 2022, the fact that hiring is strong and unemployment remains low means that we likely aren’t facing a recession.
Of course, this doesn’t make the high prices in the grocery stores and elsewhere easier to handle. But knowing that we aren’t in a recession right now may help ease some of your stress as you continue focusing on financial wellness.
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