What causes more damage, inflation or recession? | Economy

This seems to be the motto of countries hit by the gigantic inflation that is ravaging the world – and which has recently broken records for decades.

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Germany has the highest level of inflation in nearly half a century — and is dealing with an energy crisis stemming from the war in Ukraine. The US and UK achieved the highest price increase in 40 years. Latin America, meanwhile, is also under pressure due to the rising cost of living.

In Brazil, the Broad National Consumer Price Index (IPCA), considered the country’s official inflation, fell by 0.68% in July, after registering a rise of 0.67% in June. As a result, the country registered deflation – negative inflation -, the first after 25 consecutive months of rising prices.

In the year, however, accumulated inflation is 4.77%. In the last 12 months, the rate decelerated to 10.07%, against the 11.89% registered in the immediately previous 12 months.

In other words: the “firefighters” of the economy are racing to contain this fire before it becomes uncontrollable.

The specialists in charge of the countries’ fiscal and monetary policy are trying to find a solution, but they cannot ignore another source of danger: recession.

— Photo: Getty Images

But what does high inflation have to do with the economic downturn?

When inflation is triggered, central banks raise interest rates (the cost of credit) to discourage the purchase of goods or services. It is a policy that seeks to reduce consumption, with the hope that prices will fall.

With this mechanism, inflation is more controlled, but at the same time, economic growth is slowed down.

If the slowdown is too big, however, the economy stalls and the chances of the country entering a recession increase.

— Photo: Getty Images

Faced with this dilemma, the authorities have to work a real tightrope and ask themselves at all times: how long is it possible to raise interest rates without suffocating the economy too much?

This precarious balance between inflation and recession is what makes economists try to put out one fire without adding more fuel to the other.

Hence the question: is inflation worse than economic recession?

“It is not so much what is worse, but what is the first thing to be faced. I believe that a country that wants to maintain macroeconomic stability cannot afford high inflation”, argues Juan Carlos Martínez, professor of economics at IE Escola. University of Business, Spain.

“A recession is a lesser evil than persistent inflation in the economy”, evaluates the expert, in an interview with BBC News Mundo, the BBC’s Spanish service for Latin America.

Benjamin Gedan, deputy director of the Wilson Center’s Latin American Program and professor at Johns Hopkins University, in the United States, also argues that reducing the cost of living is a priority.

“Both things are bad, but inflation is more difficult to overcome in many cases”, he points out.

Chronic high inflation, he adds, imposes a lot of costs on society – which is not just related to the economic crisis.

“This also creates social tensions, as workers demand recurring salary increases, landlords impose rent increases and merchants decide to apply repeated price increases”, exemplifies Gedan.

José Luis de la Cruz, director of Mexico’s Institute for Industrial Development and Economic Growth (IDIC), understands that controlling inflation can take many years, while recessions, at least in recent years, have been overcome more quickly.

“Right now, it is essential to contain inflation because the experiences of the last 50 years show us that an inflationary spiral ends up triggering a recession”, recalls the economist.

“You can face a recession without it implying inflation, but in the other case, inflation ends up leading to a crisis.”

The United States, for example, “is paying the price of a mistake”, says de la Cruz, because the authorities let too much time pass before raising interest rates to control consumption and investment.

In this way, demand remained high and prices continued to rise, without eliminating the incentives to continue spending, analyzes the expert.

What happens in Latin America?

As in other parts of the world, Latin America also suffers from the wave of inflation.

In countries like Chile, inflation reached the historic mark of 13.1% (the highest in almost three decades), followed by Brazil and Colombia, where this rate exceeds double digits.

Countries like Peru and Mexico, where the inflationary spiral is a little lower, have also suffered the consequences of high prices, which are leaving deep marks on the most vulnerable sectors of society.

Argentina, which has a chronic inflation problem, has an open wound with a 64% increase in the annual cost of living.

Against this backdrop, the region’s central banks have applied historic interest rate hikes to try to alleviate the pressure (or lessen the force of the fire).

In good economic times, many governments used to set an inflation target in the range of 2% to 4%.

But with the cost of credit soaring, those goals have been pushed aside, at least for now.

Brazil, for example, has interest rates of 13.7%, while in Chile the cost of borrowing has risen to an all-time high of 9.7%.

Few options remain for people aspiring to buy a home with a bank loan, or for entrepreneurs planning to renovate equipment, expand operations or start new investment projects.

Clearly, the days of “cheap money”, that is, of more affordable loans, are in the past.

The rise in the cost of credit has been so rapid and profound that economists expect to see the first results of it soon.

In fact, in countries such as the United States and Brazil, inflation took a break and declined slightly, raising expectations that prices could have peaked.

Who are most affected by inflation?

“Worst of all is that inflation has the effect of a tax on the poor, who have little savings and generally work in the informal sector, with little ability to protect their purchasing power,” explains Gedan.

Given the widespread poverty in Latin America and the gigantic informal sector, the impacts of inflation are particularly severe in the region.

In this sense, the authorities did not hesitate to raise interest rates, especially given the episodes of price escalation in Latin America in recent decades.

“Given the region’s recent traumas with hyperinflation and the desire to preserve hard-won credibility by central banks, it is not surprising to see rapid action in many countries to contain price increases,” says the expert.

The debate in the United States

While inflation and recession are two economic threats, in the United States the debate has focused on how much and how fast the Federal Reserve (the equivalent of the central bank in other countries) should continue to raise rates to stop prices from escalating.

Criticized for not acting sooner, the agency has embarked on a series of interest rate hikes this year.

And as these increases put the brakes on the economy, the question many are asking is whether or not the country will go into recession.

The US is already experiencing what is known as a “technical recession”, the equivalent of two consecutive quarters of economic contraction.

But in the US, these negative numbers do not represent a true recession by US standards.

Who defines this economic stage there is an independent organization called the National Bureau of Economic Research (NBER).

The institution counts on the participation of leading economists, who meet regularly and analyze all the variables that can affect a recession process.

The definition they use is far from a mathematical formula: “[A recessão é] A significant decline in economic activity that spreads throughout the economy and lasts longer than a few months.”

The economists’ committee’s approach is that while each of the three criteria (depth, spread, and duration) must be addressed individually to some extent, extreme conditions related to one criterion may partially offset the weaker indications of the others.

Precisely because it is not a foolproof formula, there is a lot of debate in the United States about whether the country is really heading for a recession or if it will not reach that stage.

The highest authorities in the country (responsible for fiscal and monetary policy) have been optimistic, arguing that the job market remains strong.

In July, inflation dropped slightly (from 9.1% to 8.5%), giving some relief to forecasts that considered a recession inevitable in the country.

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