I heard the terms deflationary recession & inflationary recession in a podcast and would like to understand what it means, what causes them and past examples.
Deflationary recession refers to a recession in which prices are falling. An example was the Great Depression. Below you have a graph of the yearly rate of change in CPI. A negative number means a fall in prices, i.e. deflation. Shaded areas mean recession period according to NBER.
Some argue that deflation was actually a factor contributing towards the great fall in GDP, because the Fed did not act soon enough, keeping the money supply low. The Gold Standard is partly to blame for this inaction of the Fed.
Inflationary recession is when a recession is accompanied with increasing prices. It is commonly known in Macroeconomics as Stagflation. That was the case on the 1973-1975 recession in the US. The graph below shows the yearly rate of change in CPI (again, shaded area represents a recession):
The latter happened mainly because of the 1973's oil crisis where the OAPEC (oil cartel) stopped selling oil to countries supporting Israel (including the US), rising its price.
I would like to answer this question by sort of describing what each would start to look like. In an area where the population is aging, the resulting decline in incomes and spending tend to be deflationary because less money is earned and less money is spent, reducing economic activity, also known as Gross Domestic Product.
The elderly also sell assets such as stocks, bonds and their primary house to fund their retirement, and if the elderly populace is a major cohort (due to low birth rates and increasing life spans, etc.), then this mass dumping of assets is also deflationary, as the increasing supply of sellers and the stagnating supply of buyers pushes prices lower.
Also, if you take 10 million workers from secure, full-time employment with full benefits to low-paid, insecure part-time jobs with few benefits, you have there the makings of a self-reinforcing deflationary spiral in action because a significant portion of the labor force is now receiving less income, which necessarily slashes their spending and, just as importantly, their ability to borrow huge sums of money to buy vehicles, homes, overseas vacations, etc.
In consumer-dependent economies that are dependent on debt for much of the consumer spending, this decline in borrowing and spending power is extremely deflationary, as there is a lot less money available to chase the existing output of goods and services.
Japan is a case in point. An NHK TV program last Spring reported some young people in Japan are trickling back to rural villages and renting large traditional farm houses and the adjoining land for $200/month, a fraction of what they were paying for cramped studios in big cities. This is an example of deflation in action: people abandon costly housing, transportation, etc. and adopt lifestyles that generate far less income and far lower expenses--both are deflationary.
Technology is relentlessly deflationary. Where consumers once spent small fortunes buying stereo equipment and music storage (LPs, cassettes, CDs, etc.), cameras, film, photo printing, etc., game consoles and equipment, small-screen TVs, and paying for telephony, now a single device--a smart phone--combines all these functions (with some obvious limitations) in one device.
Globalization and commoditization are also deflationary. Global wage arbitrage and automation lowers production costs, and the commoditization of labor and inputs (capital and materials) push prices lower.
Declining energy costs are also deflationary, as the cost of energy affects the pricing of almost every good and service.
You may have heard a lot about printing money being inflationary, but that's not necessarily so. I cited a deflationary trend in Japan above, but I did not mention that Japan has been printing money for decades and yet they have been in a deflationary spiral for decades.
Why or how can this be? Well, if economic activity declines by $1 trillion due to lower incomes, spending, etc., creating $1 trillion out of thin air and injecting it into the economy as monetary and fiscal stimulus is more or less simply replacing the $1 trillion of deflation.
Now, the problem with classifying a recession as inflationary or deflationary is that, much like using GDP to get a pulse on the health of an economy, its past its time. We live in a different world now, we live in an economy where this coming recession will not be inflationary or deflationary, but rather non-linear.
Okay, so what is the difference between a linear and non-linear recession you may be wondering?
Linear correlations are intuitive: if GDP declines 2% in the next recession, and employment declines 2%, we get it: the scale and size of the decline aligns. In a linear correlation, we'd expect sales to drop by about 2%, businesses closing their doors to increase by about 2%, profits to notch down by about 2%, lending contracts by around 2% and so on.
What I am suggesting is that is not what we are going to experience this time around. We will experience a recession that is non-linear and asymmetric.
For example, an apparently mild decline of 2% in GDP might trigger a 50% rise in the number of small businesses closing, a 50% collapse in new mortgages issued and a 10% increase in unemployment.
I recently moved away from a state that is already and has been for quite some time going through this kind of non-linear and asymmetric recession, especially in regards to their pension crisis that they are doing a good job of keeping under wraps. I do not want to offend anyone, so I will not mention what state in the Union this was that I recently relocated from. I will just say they currently have $115 billion in unfunded liability to public pensioners. That kind of crisis leads to higher property taxes, services being cut or simply collapsing and manifesting itself in such things as potholes on almost every single road you drive on, including the wealthier neighborhoods.
But this public-sector pension crisis is just the tip of the iceberg. What happens when the gains in equities and bonds that have nurtured the illusion that public-sector pension funds are solvent and can be funded by further tax increases reverse into losses?
So a better way to start looking at and understanding recession, would be linear vs. non-linear as opposed to inflationary vs. deflationary.
A recession can be caused by two events. A decrease in demand or a decrease in supply. A decrease in demand causes prices to fall which is deflation. A decrease in supply causes prices to rise which is inflation. See the graphs below.
Examples of inflationary recession:
- The 1973 oil crisis caused 'stagflation' in the US and triggered a recession. Link.
Examples of deflationary recession:
- The Japanese asset price bubble of the 1980s has caused decades of deflation and low inflation in Japan. Link.
- The Great Depression of the 1930s. Link.
Inflationary recession - aggregate supply falls which decreases output and causes prices to rise.
Deflationary recession - aggregate demand falls which causes prices to fall.