Why inflation peaks at Recession phase

CFA Level III
#1

Hi everyone,

Would appreciate some help here!

In the Economic Analysis book (capital market expectations) P54 Businesss cycle phases table says that inflation peaks in Recession, but on P55, it says that inflation declines in Recessions.

Why does inflation rise and ultimately peak in Recessions if the output gap closed already closed in the Late Upswing phase? In which case the gap is probably wider in the Slowdown and even wider in Recession?

Can someone please explain? Thanks!

#2

Inflation should peak somewhere in the mid-late growth cycle. Recession and inflation is not unheard of, it’s called stagflation, but it’s not the norm in economic theory.

#3

Inflation is high before recession when unemployement is low which is at the end of the peak.

The four phases of the business cycle:

  1. A peak is when business activity reaches a temporary maximum, unemployment is low, inflation high.

  2. A recession is a decline in total output, unemployment rises and inflation falls.

  3. The trough is the bottom of the recession period, unemployment is at its highest, inflation is low.

  4. expansion (recovery) is when output is increasing, unemployment begins to fall and later inflation begins to rise.

Unemployment increases during business cycle recessions and decreases during business cycle expansions (recoveries). Inflation decreases during recessions and increases during expansions (recoveries).

Cycle Stage

Initial Recovery

Early Upswing

Late Upswing

Slowdown

Recession

Inflation (Lags)

Falling

Increasing

Accelerating

Leveling off

Decreasing

Confidence

Picking Up

Increasing

Booming

Waning

Plummeting

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