Readers Question: What is the difference between a recession and deflation?
- A recession is a period of negative economic growth. That means a fall in output, a fall in incomes and spending.
- Deflation is a fall in the price level (negative inflation rate)
Usually, in a recession, we see higher unemployment and a lower inflation rate (but it is quite rare even in a recession to actually get deflation and falling prices)
The official definition of a recession is a decline in output (Real GDP) for two consecutive quarters.
This shows the recession of 1990-92
Usually, in a recession, you will get a fall in the inflation rate.
In 1992, there was a fall in the rate of inflation. Prices are still rising – but they are rising at a slower rate.
Deflation
Deflation is when we get a negative inflation rate i.e. falling prices.
Since the Second World War, recessions have generally not led to deflation – just a lower inflation rate. The two recessions of 1980 and 1991 were caused by attempts to reduce a high inflation rate.
In 2009, there was a brief period of deflation (using RPI method)
For a short-time in May 2008, the RPI (which includes the cost of interest payments) became negative – deflation. But, this deflation did not last very long.
Deflation in 1920s
In the 1920s and 30s the UK experienced a considerable period of deflation (falling prices) This was due to
- Low economic growth
- Tight monetary policy – high real interest rates
- Overvalued Pound – Gold Standard caused imports to be cheaper but exports less competitive
Difference between Recession and Depression
Interestingly, many see deflation as a sign that the economy is experiencing depression rather than just recession. (Other features of depression include a much bigger and longer fall in GDP).
The great depression, saw output fall 40%
During the great depression, we also see a fall in the price level. (deflation)
About The Author
What’s your basis for stating that ‘The last two recessions were caused by attempts to reduce a high inflation rate’ ? I’ve not seen any suggestion that this was the case in 2008.
I should specify I meant 1980 and 1991 (not 2008 – as you say there was no major effort to reduce inflation (though we did get 5% cost-push inflation because of oil price)
I have a slight quibble with the above definition of deflation. Any definition should include the point that the word “deflationary” does not necessarily apply to a scenario where prices are falling. “Deflationary” is often used to refer to a policy or event which dampens or reduces economic activity (but not necessarily to the extent to causing prices to fall).