Why are governments inducing recessions?

Question

I read an article that the US government is inducing a recession because the economy is running too “hot” compared to Europe. How is inducing a recession going to help?

In: 5

Answer 1

What you read was an article about how the Federal Reserve is raising interest rates to “cool” off the economy, but that’s not *causing* a recession – its just making it more apparent that we’re already in one.

On a very fundamental level, the economy is just a summation of the total amount of goods and services that are produced in any given year. If you want to put a value on that, the easiest way to do so is to just add up the cost of all of those goods and services – which is how the GDP is calculated.

That works fine under normal conditions since the cost of goods and services typically only goes up a tiny amount each year. So if, under normal circumstances, the total value of goods and services is 3% higher than it was the previous year, 1-2% of that will probably be legitimate growth.

But at the end of the day, the cost of an item is an arbitrary number – if I produce a steel bar that sells for $10 one year and $100 the next, there hasn’t been $90 of “growth” between those two years because the amount of steel being produced is the same. Or worse, if the reason my steel bar is selling for $100 in year 2 is because there are less steel bars being produced, then there has actually been negative growth, even if more money is being spent.

We’re currently in a situation where there are less goods and services being produced in 2022 than there were in 2020. Despite that, there is more money available to spend so the cost of those goods and services is skyrocketing. That creates a false appearance of economic “growth” when what is actually happening is that the economy is shrinking. (IE, less goods are being produced while more money is being spent).

What the Fed is doing is to reduce the amount of money available. That helps to prevent prices from rising due to shortages. Once prices stabilize, the fact that there is just less stuff being sold becomes more apparent. But the Fed isn’t causing less stuff to be sold – that was already happening – its just preventing the inflation that was making that to begin with.