Regional economies go through cycles of boom and bust, affecting the value of currency. Inflation and business cycles are linked, and politicians try to balance growth and prices. A recession occurs when GDP declines for two quarters. Policymakers must balance inflation and recession indicators to set interest rates.
Regional economies typically do not remain stagnant, but go through periods of boom and bust. Some of these seasons last longer than others, and each has a unique relationship to the value of the currency in a region. Inflation, which measures how much goods and services cost, is a barometer of how much a currency can buy, while a business cycle indicates whether an economy is generating higher or lower output. A business cycle and inflation can be somewhat affected by politicians trying to keep regional production growing while keeping prices from becoming a threat to consumers.
When an economic growth is expanding, it typically means that a region is generating more production of goods and services. This expansion of business and inflation are linked because as the economy strengthens, it is likely to cause an increase in prices related to goods and services. Price increases can be reflected in some economic indicators, such as a consumer price index (CPI), reported for example in the United States and England. The CPI measures how quickly the prices of household items, food and energy are rising or falling. When this index advances aggressively, it could be representative of higher inflation in a region.
While inflation might be easily identified by economists, there are other conditions that might be more contradictory in nature. For example, it is possible for a business cycle and inflation to remain linked even when an economy is retreating or contracting. If consumer prices continue to rise, yet gross domestic product (GDP), a measure of the condition of an economy, represents a contraction, this could create a stagnant economic environment. This is likely to put pressure on the value of a country’s currency, which could adversely affect international trade, for example.
An economy experiences a recession when GDP declines for at least two quarters. This business cycle and inflation are usually in stark contrast to each other. Later, during downturns, federal policymakers may need to intervene to keep interest rates low lest an economy slow down further.
Historically, these policymakers have had to steer economies through periods when consumer prices threatened to rise while other factors, such as unemployment rates, were signaling an economic slowdown. The rate of increase in food and energy prices could indicate inflation while the employment scenario suggests recessionary conditions, creating a divide between the business cycle and inflation. This will likely make it more difficult for monetary policymakers to accurately establish the appropriate economic temperature with interest rate changes.
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