Turn on the TV or go to your favorite news site and you hear about the looming recession…the dreaded “R” word of economics. We get bombarded with all kinds of statistics and theories, but have you ever wondered what causes a recession in the first place? Read on to get up to speed and learn what you can do to protect yourself.
Growth Creates Higher Prices
When the economy is growing, businesses are making money. They spend this new revenue, buying more goods to grow their business and share the profits with their employees by giving them a pay raise. Employees go out and spend their bigger salaries, buying more things and creating a higher demand for products.
Companies can capitalize on increased demand by making more goods or raising their prices. Raising prices is especially appealing because, let’s face it, if you could make more money just by asking for it, wouldn't you?
Wages Increase
For a while it’s one big party. Businesses are making more money…you’re getting a raise…everybody’s happy. Eventually, however, prices get so high that demand drops off. People slow their spending and goods start sitting on shelves.
Inventories Rise
By this time, businesses have more goods in production and have to add them to their existing stock. This creates an inventory surplus. Now the market is flooded with goods. That’s when prices should drop, but they can't...at least not right away.
Prices Are Slow to Fall
Companies would like to cut their prices and move their goods, but they’re in a bit of a pickle. If they lower their prices, they’ll make less money and won’t have enough to pay their new bills. Bills that happen to include employee pay raises. This may not come as a shock, but cutting salaries is incredibly unpopular. It’s bad for morale and can really hurt a company’s production.
Businesses have to wait until spending picks up again or start firing employees. Either way, it’s hard for them to lower their prices and sell off the excess inventory. Prices are slow to fall, sales suffer, businesses make less money and the economy slows down as a whole.
How Do You Fix It?
Recessions are a natural part of the business cycle. That being said, there are ways to minimize its effects. The Federal Reserve, Treasury Secretary and Congress all have different tools to stimulate the economy. If they go too far by pumping too much money into the economy, it creates an inflation problem. If they don’t do enough, then the economy remains sluggish and more people lose their jobs. Their goal is to walk the middle ground, doing just enough to get businesses moving again, without creating a monster of inflation.
Protect Yourself
The good news is that you can protect yourself and your family by making solid financial decisions, like spending less than you make and paying yourself first (i.e. saving.). Also, by working for companies that stand the test of time, you can insulate yourself from job loss. Prepare yourself, be patient and you’ll ride through and up the other side again in no time.
