Sta Hungry Stay Foolish

Stay Hungry. Stay Foolish.

A blog by Leon Oudejans

The inflation-recession cycle

My blog of yesterday, Inflation + falling house prices = ?, might have suggested that inflation and a recession are independent. Well, a period of inflation is usually indeed followed by a recession. The diagram below shows their relationship in time. Unfortunately, that diagram does not show the trigger.

SOURCE of diagram

The missing link between inflation and a recession is the default Central Bank response: raising interest rates. Once CBs raise the interest rates too much, a recession becomes very likely. A recession is usually defined as two consecutive quarters of negative economic growth (eg, Investopedia).

“At its last meeting, the Fed’s Open Market Committee raised short term interest rates to 4.5 percent (the rate was 0 percent at the beginning of the year), with a forecast that rates will continue to rise well into 2023 — even though it recognizes that the rapid hikes risk bringing us a recession, high unemployment and stock market crashes.” Note: emphasis in quote by LO.

The Hill, 15 December 2022: How to help the Fed and avoid a recession

The above implies that a recession can indeed be prevented by not raising interest rates too much. Unfortunately, such a prevention usually seems like an act of luck rather than science.

To avoid an unnecessary recession, we need to pursue policies such as fiscal contraction, supply-side reforms and stiffer antitrust enforcement that fights inflation while fostering a strong economy rather than an anemic one.” Note: emphasis in quote by LO.

The Hill, 15 December 2022: How to help the Fed and avoid a recession

In my view, a 2023 recession is unlikely despite the 2019-2023 inflation surge because current inflation is caused by damages at the supply side of the economy rather than its demand side. Moreover, there is little evidence that consumption is indeed decreasing (eg, Yahoo Finance-2023).

In mathematical terms:
GDP (Y) = { Consumption (C) + Investments (I) + Government (G) } + { Export (X) – Import (M) }

The increase in (military) expenditure by Governments (G) will exceed any decrease in consumption (C). My view is inherently connected to the duration of the proxy world war between Russia and Ukraine. I fail to see any reason for ending that war: Putin cannot lose while Ukraine cannot win (eg, GPF).

Stalemate (2009) by Ben’s Brother, featuring Joss Stone
band, artist, lyrics, video, Wiki-band, Wiki-artist, Wiki-song

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

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