Inflation Versus Depression
The terms inflation and depression describe two conditions of varying severity with depression being the more serious of the two. The market wages a constant battle with inflation and it can often be a smoke signal of a coming financial crisis. An economic depression, on the other hand is the result of many economic factors working to shrink consumer spending and available capital.
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Characteristics of a Depression
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A depression is characterized by several economic conditions, including a sharp rise in unemployment, a drop in productivity, low investment in financial markets and reduced consumer spending. Wages can also shrink during an economic depression which further inhibits consumer spending power. The cycle can be a vicious one as reduced spending leads to a reduction in bank lending confidence. In a depression, financial markets stall.
Fighting Depression
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According to New York Times columnist Paul Krugman, fighting depression is thought by some economists to be easy since emerging from the dark days of the Great Depression. The Federal Reserve adds liquidity to the market. This keeps banks lending and consumers spending, thereby propping the market up. A problem with this strategy occurs when consumers are not able to take over the spending reins and the Federal Reserve ends up pumping too much money into the market leading to deflation -- a condition in which the value of money drops. This is why some economists argue to allow the market to play itself out. These economist insist that if unemployment numbers can be improved, the economy will move along with it.
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What is Inflation?
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Inflation is an economic condition in which the costs of goods and services outpaces the value of money and how money is available in the market. This means consumers have less to spend and are forced to cut back to essentials. Inflation can often be a precursor to an economic recession due to the drop in consumer spending. If a recession is deep enough it may be referred to as an economic depression.
Fighting Inflation
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The Federal Reserve may increase the flow of money into the market by providing more capital for banks to lend. This can work to fight inflation by encouraging banks to lend money to consumers who use that money to purchase homes, new cars and other high-ticket items. The Federal Reserve Board can also control prevailing national interest rates as a means of fighting inflation.
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