Understanding.....

Inflation --> Recession -–> Deflation – Depression

The Financial crisis that started in US in 2007 June has snowballed into a worldwide tsunami that threatens the health of virtually every economy today.

In India, what started as a mere profit booking at 21000 levels on BSE in Jan 2008, has come to ground reality. For sometime we were talking about high inflation ( when Oil was quoting at US $ 147 / bbl ). Then it was all about recession and now people are talking about deflation.

Let us debug what all these technical terminologies mean in simple language.

Inflation:

In simple terms your money loses value. For instance, the quantum of product (say Sugar) you bought for Rs.100 a few months back, cannot be bought for Rs.100 now. You buy something less. In other words, you cannot maintain the same standard of living for the same budget in a inflationary situation. Either you need to spend more money to get the same standard or you need to reduce your expenditure to fit into the same budget.

Recession:

Recession is a period of reduced economic activity. Simply put, demand for goods & services fall steeply for a number of reasons: GDP falls as factories struggle to maintain production. Joblessness grows. Incomes shrink. Spending gets hit. Investments goes into hiding. Stock market tanks.

The rule of thumb is : recessions are often indicated by two consecutive quarters of negative growth (or contraction) of GDP.

A point to note is : Recession often results in various factors listed above – one being joblessness and shrinkage in income. Those people who lost their jobs / got salary cuts ( say 30% or so), will be left with little money to spend. As a result the consumptions falls leading to lesser demand for goods. When the Demand-supply ratio falls below 1, inflation falls drastically – often resulting in Deflation.

Deflation:

It is a general decline in prices over a period of time – a sustained fall. When inflationis negative, the economy reels under deflationary period. When inflation falls, logically it means your money can buy more goods (antonym of Recession).

Think like this : Money has value. During Inflation money loses value. Deflation on the other hand pushes up the value of money. In other words, the supply of money goes down (demand of money goes up) whereas the supply of goods goes up (demand of goods goes down).

As a antonym of Inflation, deflation on the fact of it may look positive. You buy more for the same money ( Rs.100 – Sugar example). But behind the curtain, DEFLATION IS THE DEVIL IN DISGUISE. To know the real effect of Deflation, read another article posted about deflation.

Depression:

A depression is a severe economic downturn that lasts several years, This is a time when an economy keeps contracting continuously, shedding jobs, production, investment and consumption when the pace of every economic activity falters and some time ceases all together.

And example of depression is: The Great depression in 1929 in USA lasted for 10 years. It ended only with the onset of war economy of World War II – what economist Paul Krugman later called “the deficit spending programme known as the Second World War.

During this depression, as many as 9000 banks failed.By 1933, depositors had lost as much as US$ 140 billion in deposits.

Where do we stand :

Having understood the elementary features of these technical terminologies, where is India in this pipeline : definitely we crossed Inflation. Currently we might be in recession or early deflation. Whether it is to drift into depression depends on how our economy battles the challenges.

When compared to US (where 80% of GDP is credit dependent), or UK (86%), India has hardly 6% dependency on credit. Hence India should fare much better than the rest of world. Let us hope so…