From Inflation to Recession, How to Master Modern Economic Vocabular

Inflation, Recession and high prices are dominating the news lately.

After two years of government stimulus payments, eviction moratoriums and student loans in forbearance to fight the pandemic, prices are finally catching up. Instead of being swept into this moment of confusion, it is time to brush up on the basics of macroeconomics.

Hope this serves as a one-stop shop for information as your personal economy continues to develop. You can also dive into the details on each topic via Investopedia.com

All hands on deck if you want to break it down.

Table of Contents

Do you even know what the Federal Reserve System is?

For simplicity, the Federal Reserve System is the most powerful financial institution in the world. Most people call it the Fed, but not be confused with the Federal government (who we also call the Feds)?

All you need to know is that the US President has no authority over the Federal Reserve.

Founded in 1913 to provide the country with a safe, flexible, and stable monetary and financial system after the first Great Depression, the Fed reserves is not owned by anyone.

The Fed has a board that is comprised of seven members, led by the current chair Jerome H. Powell. Sounds like he is a Black person but he is not.

The Fed’s Board of Governors, on the other hand, reports to and is directly accountable to Congress.

Yep, there are layers to this confusion.

The Fed issue directives to 12 Federal Reserve banks with their own presidents. The main goals are to foster economic conditions that achieve stable prices and maximum sustainable employment.

What can the Fed do exactly?

The Fed can conduct national monetary policy by influencing monetary and credit conditions in the U.S. economy to ensure maximum employment, stable prices, and moderate long-term interest rates. This is known loosely as quantitative easing.
Supervise and regulate banking institutions to ensure the safety of the US banking and financial system and to protect consumers’ credit rights.
Maintain financial system stability and containing systemic risk.
Provide financial services, including a pivotal role in operating the national payments system, depository institutions, the US government, and foreign official institutions.

So the Federal Reserve fights inflation? Well sort of.

Inflation is the decline of purchasing power of a given currency over time. It happens all the time but for some reason, we forget about it when inflation is low or when we are tackling another topic-du-jour.

In nerd lingo, inflation is a quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time.

The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. The best example is your shopping cart at the local grocer.

There was a time when $100 meant that the cart was stocked to the brim with over 60 items. Now, you will be lucky to get 15 items. The recent decline in major stocks is a subsidiary effect of rising inflation. cause by too many dollars chasing too few goods.

To fight high inflation, the Fed raises interest rates but doing it too much can slow things down. To spur spending and create more demand, they lower rates. In doing so, it speeds things up.

Causes of Inflation

An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy:

Printing and giving away more money to citizens
Legally devaluing legal tender (currency)
Loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market

Is the opposite of inflation, Deflation?

Deflation describes the drop in prices for goods and services. Deflation slows down economic growth. This normally occurs during times of economic uncertainty when the demand for goods and services is lower, along with higher levels of unemployment.

When prices fall, the inflation rate drops below 0%.

What we want to avoid is Hyperinflation

Hyperinflation describes a period of rapid, excessive, and out-of-control price increases in an economy.

While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.

Although hyperinflation is a rare event for developed economies, it has occurred many times throughout history in countries such as Venezuela, Germany, Russia, Hungary, and Argentina.

The biggest risk today is long-term high inflation rates.

What can be worse than a recession?

Stagflation

Stagflation is characterized by slow economic growth and relatively high unemployment accompanied by rising prices due to inflation. It’s one of the worse possible combination that can push beyond a recession right into a depression.

80% of economists think that Stagflation is our modern long term risk.

Potential triggers for a stagflation?

Global price of Oil, Gas and Energy
Poor macroeconomic policies
The removal of the Gold Standard

Wait there’s also Disinflation

Disinflation occurs when price inflation slows down temporarily.

This term is commonly used by the Federal Reserve when it wants to describe a period of slowing inflation. Unlike deflation, this is not harmful to the economy because the inflation rate is reduced marginally over a short-term period.

Prices do not drop during periods of disinflation and it does not signal an economic slowdown.

Finally, what is a Recession?

A recession refers to a significant decline in general economic activity in a designated region for two consecutive quarters. It’s sometimes aligns with an increase in unemployment and a decrease in supply demand.

The National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

As such, it is still on the fence if 2020 can be defined as a recession since it lasted for about a month. While they might not call it, your personal household economy is likely in a recession.

I guess record high inflation is better than a Depression?

A depression is a severe and prolonged downturn in economic activity. As such, a depression is an extreme version of a recession that can lasts three or more years. Unfortunately, it has the side effect that leads to a decline in real gross domestic product (GDP) of at least 10% in any given year.

Depressions are relatively less frequent in the modern era, but tend to be accompanied by high unemployment and low inflation. However you spin it, it’s really bad on average to low earners.

Read up on how you can thrive through a recession.

Understanding Depressions

In times of depression, consumer confidence and investments decrease, causing the economy to shut down. Economic factors that characterize a depression include:

Substantial increase in unemployment
A drop in available credit in contrast to an increase in savings
Diminishing GDP output and productivity w/a consistent negative GDP growth
Increase in bankruptcies and debt defaults
Reduced global trade and commerce
Bear market in stocks
Sustained asset price volatility and falling currency values i.e Euro falling in line with the dollar
Low to no inflation, or even deflation