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Which is worse, inflation or recession?

Published in Economic Conditions 4 mins read

A recession is generally considered worse than inflation due to its more immediate and widespread negative impacts on employment and overall economic stability. While both can harm your finances, a recession often leads to more severe consequences for the average person.

Let's break down the distinct characteristics and impacts of each to understand why.

Understanding Inflation

Inflation refers to the rate at which the general level of prices for goods and services is rising, and subsequently, the purchasing power of currency is falling. In simple terms, your money buys less than it used to.

How Inflation Affects You:

  • Eroding Purchasing Power: The most direct impact is that the cost of living goes up. Your dollar doesn't stretch as far as it used to for groceries, gas, rent, and other necessities.
  • Income Lag: If your income doesn't increase at the same rate as inflation, your real income effectively decreases. This can be particularly painful for those on fixed incomes.
  • Savings Value: The value of your savings can diminish over time if they are not earning a return higher than the inflation rate.
  • Investment Shifts: Inflation can influence investment strategies, as certain assets may perform better or worse in a high-inflation environment.

For a deeper dive, explore what inflation means on Investopedia.

Understanding Recession

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

How a Recession Affects You:

  • Job Loss and Unemployment: One of the most devastating impacts of a recession is widespread job cuts and a rise in unemployment. Businesses reduce operations, lay off workers, or freeze hiring to cut costs.
  • Wage Cuts or Stagnation: Even if you keep your job, you might face wage cuts, reduced hours, or a freeze on raises.
  • Decreased Consumer Spending: People tend to spend less during a recession due to job insecurity, reduced income, and general economic uncertainty, which further slows down the economy.
  • Business Failures: Companies may struggle or go out of business, leading to more job losses and a reduction in available goods and services.
  • Asset Depreciation: The value of investments like stocks and real estate can decline significantly during a recession.

Learn more about recessions from sources like the National Bureau of Economic Research (NBER).

Why a Recession is Generally Worse

While inflation can certainly be painful and complex, causing prices to rise and your income to struggle to keep pace, it doesn't typically lead to the same level of widespread job loss or wage cuts that characterize a recession. The primary reason a recession is considered worse is its direct and severe impact on employment and income stability.

Key Differences Summarized:

Feature Inflation Recession
Core Problem Rising prices, eroding purchasing power Economic contraction, reduced activity
Job Impact Generally does not cause widespread job loss Widespread job losses, high unemployment
Income Impact Income may not keep up with rising costs Wage cuts, reduced hours, income loss
Economic State Economy might still be growing (or overheating) Economy is shrinking (negative growth)
Primary Threat Diminished purchasing power Loss of livelihood and financial security

Impacts on Your Finances

Both economic phenomena require different strategies to navigate:

Navigating Inflation:

  • Budgeting: Adjust your budget to account for higher costs of essential goods and services.
  • Income Growth: Seek opportunities for salary increases, side hustles, or investments that outpace inflation.
  • Smart Saving: Consider inflation-protected securities or assets that tend to hold value during inflationary periods.

Navigating a Recession:

  • Emergency Fund: Build a robust emergency savings fund (3-6 months of living expenses) to cover periods of unemployment or reduced income.
  • Skill Development: Invest in skills that make you more indispensable or pivot to industries less affected by economic downturns.
  • Debt Reduction: Pay down high-interest debt to free up cash flow and reduce financial burden during uncertain times.
  • Diversify Investments: Review your investment portfolio for diversification and risk management.

Ultimately, while both inflation and recession present significant challenges, the widespread job losses and severe income disruption characteristic of a recession tend to have a more immediate and profound negative impact on individuals and the economy at large.