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What is Inflation? What is a Recession?

BY CARTER E. ANTHONY, CFA

Inflation is an overall increase in the price of goods and services in an economy.

Over time, currency loses value giving up purchasing power.  Whatever a dollar can buy today, it buys less tomorrow.

Inflation occurs for a variety of reasons:  Economic stimulus plans, growth in money supply, supply chain issues, i.e., too much money chasing too few goods.

There was a time in the 1980s-90s when financial planners plugged 5% inflation into a plan.

Since the financial crisis of 2007-2008, inflation has run at 0%-2%.  A longtime banker once told me that at least 2% inflation is needed to bail banks out of bad loans.

With all due respect and apologies to drunken sailors, the government has been spending our tax money like drunken sailors and an inflationary spiral upward has occurred.

The most common inflation measure is the monthly Consumer Price Index for Urban Consumers (CPI-U) produced monthly by the Bureau of Labor Statistics.

It measures price changes paid by urban consumers for a representative basket of goods and services consisting of food, energy, durables like cars and clothing, services and healthcare.

Some economists prefer to use the “Core” CPI which excludes more volatile food and energy.

Core CPI is quite misleading in today’s economy.  CPI-U for June was a horrendous 9.1%.

A recession occurs when a nation’s economy experiences negative Gross Domestic Product (GDP) including declining demand for goods, declining measures of manufacturing and production, contracting levels of income and rising levels of unemployment.

Recessions are considered an unavoidable part of the business cycle and a cleansing of the economy, eliminating excesses.

After two consecutive quarters of declining GDP, the National Bureau of Economic Research will announce that we are officially in a recession!

COVID 19, the pandemic shuttering businesses and interrupting the supply chain, all have created the currently expected recession.

Most are caused by a sudden economic shock. Most notably, in the 1970s, OPEC cut off our oil supply; in the 1980s, tight money supply curbed inflation created a recession; in the early 1990s, another oil shock occurred; and in 2007-2008, subprime mortgage lending brought the financial sector to its knees.

On average, recessions last 11-12 months.  The shortest on record was the 3-month pandemic-induced in 2020.

The Federal Reserve Board is responsible for maintaining the economic and financial stability of the country.

More specifically, it must maximize employment while keeping prices stable.

It does so through its Federal Open Market Committee (FOMC) by adjusting interest rates and the money supply.

The Fed Funds Rate, the rate at which banks borrow from the Fed has been near 0% since 2010 in an effort to stimulate the economy after the financial crisis of 2007-08.

In June, the FOMC increased the Fed Funds rate by .75% to a range of 1.50% to 1.75%, the largest increase since 1994.

Some have called it a “broadside” in the attack on inflation.

A .50%-.75% increase is expected at the meeting July 26-27. Watch your borrowing rates rise!

In almost every case, the S&P 500 has hit its high seven months before the start of a recession and it has bottomed out four months before the end of the recession.

During the last four recessions since 1990, the S&P 500 has declined an average of 8.8%.

Through June 30, 2022, the stock market had its worst six months since 1970, 52 years, falling 20.6%.

The S&P reached its highest on January 3, 2022 at 4,796.56, six months ago, and it is officially in a bear market.

 

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