It may seem strange that the government and federal reserve want to purposefully cause a recession. During a recession, the economy shrinks, companies lay off workers, and things get miserable all around. So why then would they want to start a recession?
In a previous article, I talked about what was causing inflation last year. Since that time, a war in Europe and lockdowns in China have led to even more inflation.
Inflation: Bad for people
People really really hate inflation. Ask anyone who has not been able to buy a house in the last couple of years because house prices have gone through the roof. Everyday items like groceries or gas seem to go up in price… well, every day.
People see their money losing value and feel poorer because prices keep increasing. The worst part is that even though prices go up every day, salaries increase only once a year.
Inflation: Bad for the government
If people think prices will go up tomorrow, they will buy things today to avoid paying more tomorrow. When enough people start doing this, prices go up even more (because of the increased demand). Once everyone starts to expect inflation, it becomes a self-fulfilling cycle.
Although people don’t like a recession, people dislike inflation even more. They eventually get fed up with inflation and vote the government out.
How can government beat inflation?
As any student of economics knows, prices are determined by two things: Supply and Demand. During times of high inflation, more demand and less supply lead to higher prices.
Governments cannot do much to increase supply. They cannot manufacture new stuff or fix the supply chains or force people to get back to work in order to produce more things.
The only thing Governments can influence is the demand side. If demand gets reduced, economics 101 tells us that prices will come down.
How can governments reduce demand? They can do this by raising interest rates. As interest rates go up, it becomes more expensive to borrow and spend money. For example, mortgage (home lending) rates have more than doubled to 6%. This makes buying a home much more expensive, hence crushing housing demand.
Rising interest rates also lead people to save more (because they get more interest on their bank deposits). The result is people save more and spend less. This reduces demand, but it also means the economy slows down, and we have a recession.
The government is caught between a rock and a hard place…. it has to destroy demand and push the economy into a recession in order to beat inflation. Let us hope it is a mild recession.
No Inflation?
One area where there is no inflation is stocks. Stocks have come down a lot over the last few months. While that is painful to watch, one should continue to invest regularly.
If your favorite store had a 30% sale going on, you would rush to buy. But the stock market is the only place where people don’t buy when there is a sale going on!
If you are a time billionaire, this stock market sale is the best thing to happen to you. Enjoy!!