Inflation or Recession – Which is Worse?

Overhead interstate sign that says Heading for recession? with a sunset in the background

Lately, it’s hard to watch the news or go online without seeing two popular buzzwords being tossed about – inflation and recession. Most of us are pretty familiar with inflation because we’re experiencing it each time we fill up our gas tanks or buy groceries. Recession, on the other hand, seems to be lurking nearby and financial experts debate how likely we are to enter into one. Many ask, which one is worse? How worried should I be? Or even – what do they mean and how are they different?

Basically, inflation and recession describe the momentum of an economy. Inflation makes the economy move ahead at full speed, sometimes uncontrollably, leading to price surges and a higher cost of living. A recession is the opposite and is marked by a much slower economy and by a decline in economic activity and potentially higher unemployment.

Simply put, inflation hits your household finances. A prolonged period of inflation means that prices will continue to increase, and the same amount of money will buy you less over time. Wages tend to rise naturally during inflation to compensate for this, since inflation is a byproduct of a surge in demand. If inflation gets out of control, everyone feels poorer. And unfortunately, people with fixed incomes are affected more because they don’t necessarily have the income to keep up with rising prices. In fact, inflation could even push some households which have recently left poverty right back into it.

A recession, on the other hand, is characterized by a decrease in activity throughout the economy. This can manifest itself in different ways, like lower production levels, fewer jobs, and less spending by consumers and businesses.

Now, the economy going backward isn’t the same as you getting poorer. Heck, even my teen daughters are feeling the direct impact of inflation for the first time in their lives. The cost of fueling their cars has them carpooling with friends – and sometimes even asking Jill or I for rides to preserve their gas tanks! So, while a recession feels bad because the economy is creating fewer jobs, inflation feels bad because your money is worth less.

Look, inflation and recession are closely linked: To battle the high prices caused by inflation, the Federal Reserve could raise interest rates to help tame inflation. By raising rates, the Fed’s goal is to try to make you slow down your spending. For example, when the cost of money goes up for a car loan or mortgage or something else you want to spend money on. At some point, you’re going to pull back. The higher cost of money reduces your purchasing power — what you can afford to buy — and the Fed is effectively making you buy less. And the goal of that is to bring down inflation.

But it isn’t an exact science and there’s no guarantee the interest rate increases will work. For example, if the Fed raises rates too fast, it can trigger an economic slowdown, essentially creating a recession. This has some folks asking, is soaring inflation worse than the recession the Fed may trigger by aggressively fighting it? Is the cure here worse than the disease? 

While the Fed’s actions to date do not guarantee a recession, they may have already made one more likely. Moreover, if they aggressively raise rates, I believe that a recession is quite probable.

So given this, how should you be positioning your portfolio?

Well, folks, inflation has a tendency to hit individuals immediately so it’s crucial to manage it to the extent you can, especially for those that are nearing or in retirement or just need to make a large purchase.

But you need to be prepared for a recession, too. In fact, a solid retirement planning system with a strong downside risk management program should anticipate and have mitigating techniques for any number of possible economic environments. Folks, if you have not implemented a downside risk mitigation system into your strategy, why? Just think back to years like 2008, 2020, heck even right now since the beginning of the year, what has been your strategy?  Are you just holding on, hoping things will be ok?  Hope is not a very good strategy. A sound retirement strategy focusing on quantitative data may just be your ticket through these challenging times.  It may just help to put you in the highest probability of financial success. 

So, which one is worse?  Well, that’s debatable but we might just find ourselves dealing with both at the same time so make sure you have a plan.  Do you have one?

And as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc.

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