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Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

Inflation? Recession? Both?

1 August 2022

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I borrowed my title from a recent Reuters email. The combination of a (small) recession and (high) inflation does not make logical sense. Stagflation would make sense. This combination is, however, a rare phenomenon. Usually, it’s either a recession or inflation and not both.

In macroeconomics GDP = Consumption + Investment + Gov’t consumption + Export − Import.

A recession is defined by two subsequent GDP contractions. Usually, GDP contractions are about decreasing consumption. Economists claim that the high American inflation is demand-driven (eg, WSJ). Hence, it should be impossible that US consumption has declined. That leaves Export and Import.

The very strong US$ – compared to other currencies like Euro and PST – should then be the culprit for the US “recession” that was announced on 28 July 2022. A strong US$ makes export more expensive and import cheap. The trading part in the GDP formula (above) would then drag down American GDP.

My analysis might be the reason why US financial markets do not seem worried and even posted gains following the “recession” announcement. News media reports, however, followed the partisan political lines. Nowadays, opinions matter and economic facts are a (political) nuisance.

According to a recent WSJ article, European inflation is different in nature and supply-driven rather than demand-driven. A weak Euro/US$ will indeed increase import prices which will translate in higher production and consumer prices. Early reports claim that European consumption is already downwards.

It’s unclear yet how this will affect European GDP because of balancing factors, like: consumption down, government consumption up, exports up, imports down.

We might just be in a technical, definition-driven recession. Still, a decreasing European consumption is far from technical for many people. Prioritizing must-have though surging energy cost over nice-to-have expenditures (eg, fashion, groceries, Netflix subscriptions) helps coping with inflation.

To battle rising inflation (if possible at all), Central Banks (eg, ECB, Fed) are increasing interest levels. This is causing another consumer budget shock as rising mortgage interest cost must compete with rising grocery and heating cost. Hence, the housing market is cooling down in volumes; not yet in prices.

Despite messages from Big Tech companies about reducing the volume of new hires, the labour market is tight and unemployment is (very) low. That fact alone contradicts any emerging recession.

If there is a recession then it’s the weirdest one ever.

So Weird (2008) by State Shirt (a.k.a. Ethan Tufts)
artist, lyrics, video, Wiki

Note: all markings (bolditalicunderlining) by LO unless in quotes or stated otherwise.

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