The Economic Cycle

Introduction to Money

Inflation and recession are recurring phases of a continuous economic cycle. Experts work hard to predict their timing and control their effects.

Inflation occurs when prices rise because there is too much money in circulation and not enough goods and services to spend it on. When prices go higher than people can or will pay, demand decreases and a downturn begins.

Inflation - Since inflation typically occurs in a growing economy that is creating jobs and lowering unemployment, politicians are willing to risk its problems. However, the Fed prefers to cool down a potentially inflationary economy before it gets out of hand. So, what the Fed does is, it sells government securities, which has the effect of raising interest rates that slows borrowing.

Most economists agree that inflation is not good for the economy, because over a period of time, it destroys value, especially the value of money. Inflation may also instigate investors to buy things they can resell later at huge profits, like art or real estate, rather than putting money into companies that can create new jobs and products.

Deflation - When the rate of inflation slows, it is described as disinflation or deflation. It is a widespread decline in the prices of goods and services. Deflation has the potential to undermine employment and production.

Depression - Most developed economies try not to let the economic cycle run unchecked because it might create depression like the one after the stock market crashed in 1929. In a situation like that, money becomes very tight - the economy virtually comes to a stand still, unemployment rises and businesses collapse.

Recession - It seems that recession follows depression. The Fed can, then, create new money to make borrowing easier. As the economy gradually picks up, sellers sense rising demand of their products or services and begin to raise prices.