The Economic Cycle

Here is the economic cycle in a nut shell; 1. Demand increases lead to price increases (inflation). Price increases lead to decreased demand. 3. Decreased demand and price decreases lead to a recession.  4. Repeat.

Typically, inflation occurs alongside a growing economy. If inflation rises too much, the government sells securities and then buys them back when inflation is back under control prior to the economy shrinking. Every major economic player now manipulates the economic cycle so that is more controlled which prevents cataclysmic events.

When Fed rates are low, banks borrow more, and lend more to consumers. When consumers have more credit, they buy more, creating economic growth. Typically, in a recession, the Fed increases money supply so that this ‘borrow and buy’ spark heats the economy.

The major downside of more money and inflation is that it literally destroys the value of money. This is why milk and other items used to have much lower price tags. It is because the value of a dollar used to be worth much more than it is today. When inflation is high, it is best to buy some tangible assets as opposed to keeping your money in liquid cash. Typically hard assets like real estate will hold value and increase in price as inflation occurs.

However, there are winners and losers with inflation. Debtors love inflation because collectively, the ‘value’ or ‘amount’ of debt they have to pay is less comparatively speaking. The losers are people whose wages do not adjust accordingly with inflation.