Many consumers around the U.S. -- and the world -- are feeling the pinch when it comes to finances. Unfortunately for many of us, most things are just a lot more expensive than they used to be. Whether it’s food at the grocery store, prices at the gas pump, or other goods and services you’re purchasing. Which can cause people to wonder: Is it inflation? A recession? Or something else?
While you may hear both of those terms, it’s important to understand what constitutes a recession and what’s just regular old inflation.
Keep reading to learn more about the differences between the two.
What Is Inflation?
Put simply, inflation is what happens when the prices of goods and services are increasing. This can be tough on consumers because it means the same amount of money doesn’t go as far as it used to. In an inflationary environment, while prices are increasing, your wage or salary may not necessarily be increasing to keep pace. Which means your money is, essentially, worth less than it was before.
The current situation that most of us are feeling right now is indeed inflation. Inflation is most often measured with the Consumer Price Index (CPI), which monitors the price for certain goods and services over time. The Bureau of Labor Statistics reports on the CPI and defines it in this way:
“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 most recent CPI report by the BLS, prices for consumers have increased an average of 9.1% in the past year, from June 2021 to June 2022. This increase in prices is the largest single-year increase since the period ending in November 1981.
So if you’re noticing your grocery bill is more expensive than it used to be, you’re not alone, and it’s not all in your head. Things truly are more expensive right now.
What Causes 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 good or service’s value increases.
For example, let’s say Taylor Swift debuts a new phone case with little cat ears on it at a red carpet event. Fans start buying the same phone case in droves, to the point where it becomes very difficult to find any more of these cases online, 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 lemonade stand each summer. Normally, the cost of lemons and sugar is $5, which allows her to serve 20 customers. She charges each customer $1 for a cup of lemonade, giving her a profit of $15. But this year, the cost of lemons and sugar has increased to $10. In order to make the same profit -- or higher -- your daughter would need to increase the cost of her lemonade.
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. (Note: 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. With that in mind, the cafeteria decides to raise its lunch prices, knowing 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 illustrate on a smaller scale how these types of inflation may function on a macroeconomic level.
What Is a Recession?
Recessions are something that no one likes to think about. And when inflation is high, it may make you feel worried that a recession is coming -- or that we are already in one. However, the truth is that recessions and inflation are not always related to each other.
A recession is what happens when your country’s economy isn’t doing well. There are drops in economic activity, high unemployment rates, and the stock market may be heading in an unfavorable direction. But it’s not easy to find an agreed-upon 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 is nigh. For example, even if the U.S. GDP was to fall for a second consecutive quarter in 2022, the fact that hiring remains strong and unemployment is 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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