Recession vs. Depression vs. Inflation

Recessions, depressions, and inflation: all daunting words. Recessions mean the economy is slowing down. They are a normal part of life, though not much fun to get through. Depressions are exceptional, super-charged recessions when things get really, really bad. Governments do their best to keep recessions from becoming depressions. Inflation can play a role in both cases.

We’ll learn more here about recessions and depressions and the way inflation is linked to both.

Inflation is defined by an increase in prices, specifically as measured by the Consumer Price Index (CPI), which calculates the change in prices paid by consumers for goods and services.[3]

Inflation sucks the value out of your dollars. What you could afford yesterday may no longer be in your budget. The easiest example is, of course, the price at the pump. In 2022, gas prices hit the highest ever on average.[4]

Meet the Expert

Jessica Goedtel, Certified Financial Planner and owner of Pavilion Financial Planning.

Because your lifestyle is getting more expensive, chances are you are starting to cut down on luxuries, even the small ones like pedicures and facials, and trading in brand name items for generics. You may also be holding off on upgrading your phone and maybe trading your SUV in for a car that gets better mileage.

A recession is a drop in economic activity for multiple months. Gross Domestic Product (GDP), the value of goods and services in an economy, is commonly used as a way to measure economic activity and two consecutive quarters of a negative GDP is usually referred to as a recession.[1]

Another way to measure a recession is through the National Bureau of Economic Research’s recession indicator which considers far more factors including payroll, retail prices, individual income, and industrial production in addition to GDP.[2] The NBER’s recession call is the “official” one, though it can sometimes come after a recession is already over.

“While challenging to live through, recessions are a normal economic cycle,” says Jessica Goedtel, Certified Financial Planner and owner of Pavilion Financial Planning. “The question isn’t if a recession is coming but when."

Recessions, which last an average of 11 months, according to Capital Group, can be caused by imbalances in the economy or big shocks. The 2007-2009 recession was caused by excess debt in the housing market, according to Capital Group, while in 2001, that recession was the result of tech stocks that were overvalued and collapsed.[8]

Tip

“The question isn’t if a recession is coming but when," says Jessica Goedtel, Certified Financial Planner and owner of Pavilion Financial Planning.

COVID-19 and the subsequent stay-at-home measures to prevent the spread of the disease smacked the economy and obliterated millions of jobs, though it was the shortest in history, lasting just two months.[9]

With greater unemployment, you have reduced spending. Companies make less money and end up themselves spending less and cutting costs, which can include additional jobs. This may also be reflected in stock markets, where company shares may drop as they report less revenue. The chances for a nasty little cycle of negativity are high.

Usually in a recession, inflation falls, and the U.S. central bank, known as the Federal Reserve, will lower interest rates (which determine how much you pay for your mortgage and credit cards, among many other things) to get people borrowing money and spending again.[11]

In simple terms, a depression is a really, really bad recession. The economy dips harder, and the bad times last longer. A depression is marked by years of negative GDP, unemployment above 10%, decreased industrial output and a stock market crash.[5,6]

While a recession may only last for a few months or a couple years, a depression can last for many years to a decade and take an entire generation to fully recover from. The good news is that they are far less common than recessions. The last one was the big one, The Great Depression.

As noted above, the Fed will lower interest rates to stimulate economic activity and prevent a recession.

In times of expanding inflation, however, the Fed does the reverse. It hikes rates to make it expensive to borrow money and invest and spend, thereby making it less attractive to spend.

In the U.S. in 2022, the year started out with record low interest rates. The economy is slowing, but inflation is persistent. The Fed is currently hiking interest rates to bring down inflation, rather than focusing on the economy. The results of these strange times remain to be seen.