Yahoo Finance I’m an Economist: Here’s Why a Recession Is Worse for Your Wallet Than Inflation
There’s no doubt that recessions and inflation are both challenging to live through. During a recession, your job is at risk, your savings and emergency funds can dwindle, and bills pile up. You notice inflation when your grocery bill gets higher each month, or when filling up your car costs more than it used to. Your paycheck might not stretch as far as it once did.
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Neither situation is fun. But which is worse? GOBankingRates spoke to economists, and the consensus was that, for most people, recessions tend to be worse. Here’s why:
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Job Losses and Wage Cuts
Recessions tend to take money out of people’s pockets immediately. It’s common for people to lose their jobs, have their hours reduced, or even have their pay cut.
“In a recession, companies typically lay off people, reduce hiring, and limit or eliminate pay increases,” said Dean Kaplan, president of The Kaplan Group. “Unemployment rates increase and available jobs decline. Even if you don’t get laid off, there is downward pressure on wages and less opportunity to move to a new or higher-paying job.”
If you can keep your job, you might still find it hard to get a raise or move to a better-paying position.
“If you’re in a field that depends on consumer spending, a recession will hurt worse than inflation,” said Scott Lieberman, founder of TouchdownMoney.com. “When a recession hits, people tend to pull back their spending on luxuries. So if your job is based on things people can afford to do themselves, a recession will cause real problems.”
If you work in entertainment, travel or high-end retail, a recession means fewer customers and lower income. This creates a vicious cycle where less money in consumers’ pockets means less money being spent in the economy, exacerbating the recession. Essential services, on the other hand, are always in demand.
“If your job is recession-proof, inflation will be worse for you,” Lieberman said. “In some fields, such as plumbing or healthcare, people can’t cut back when those needs arise. So you won’t feel the effects of a recession as much as you would inflation. You might actually do better in a recession because you’ll still be able to afford items and might get them at cheaper prices.”
Investment Losses
The markets also suffer during recessions. Stock prices tend to decline before a recession and stay low until there are signs of economic recovery. The value of any investments you have can drop significantly.
“Stock prices typically decline in advance of a recession and remain lower until there is hope on the horizon,” Kaplan said. “Interest rates go lower to help the economy recover. For consumers, this means they are earning less on their savings, and their investments are worth less if they need to be sold to cover current expenses.”
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Borrowing Becomes Tougher
Recessions often lead to higher interest rates on loans. This means it will be more expensive to buy a house or a new car, for example, and it can be harder to qualify for that loan, too.
“It is always harder to borrow during a recession,” Kaplan said. “While the interest rate on savings may be lower, the interest rate on new borrowings could actually be higher given the higher overall economic risk that lenders are facing.”
How Inflation Is Different
Inflation has a more complex impact on your finances. Prices for goods and services rise, which can be painful if your income doesn’t increase at the same rate. However, inflation doesn’t tend to cause the same level of widespread job loss or wage cuts as a recession.
“Recessions take money out of people’s pockets immediately,” said Albert “Pete” Kyle, professor of finance at the University of Maryland’s Robert H. Smith School of Business. “Inflation sometimes takes money out of people’s pockets in the short run and sometimes adds money to people’s pockets in the short run. But it always imposes additional long-run costs which must be paid to bring resulting inflationary expectations back down.”
To try to control inflation, central banks often raise interest rates. This can slow down economic growth and lead to higher unemployment, similar to the effects of a recession.
Politics and Inflation
Inflation also tends to be accompanied by a politically divisive atmosphere. In recent years, political division has intensified due to so-called “culture wars.” This environment can lead to inflation as competing political parties, driven by the fear of losing power, may adopt populist policies that prioritize short-term gains over long-term economic stability.
“Inflation tends to be accompanied by a politically divisive atmosphere,” Kyle said. “The mechanism is that competing parties both have such a fear of losing that they forsake rational policies in favor of populist policies which might help win the next election.”
Both left-wing and right-wing populist policies can contribute to inflation. These policies might provide immediate financial benefits but ultimately lead to higher inflation and long-term economic costs.
“When Hugo Chavez came to power, he financed increases in social spending by running large government deficits, which were financed by printing money,” Kyle said. “The result was hyperinflation, a collapse of the Venezuelan economy, and a collapse of political institutions. This is another example of divisive politics leading to populist inflationary policies putting money into people’s pockets in the short run but emptying people’s pockets in the long run.”
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This article originally appeared on GOBankingRates.com: I’m an Economist: Here’s Why a Recession Is Worse for Your Wallet Than Inflation
