What Happens to CPI During Recessions?

The Consumer Price Index (CPI) measures the average change over time in prices paid by urban consumers for a market basket of goods and services. A recession signifies a significant decline in economic activity. This article explores how the CPI tends to behave during periods of economic contraction.

Understanding CPI and Recessions

The Consumer Price Index (CPI) is a key indicator of inflation, reflecting the change in prices for goods and services purchased by consumers. The U.S. Bureau of Labor Statistics (BLS) calculates the CPI by collecting price data each month from thousands of retail stores, service establishments, and rental units. This data tracks changes in the cost of a “market basket” of over 200 categories of goods and services, from food and housing to medical care and transportation. The CPI directly impacts purchasing power, influences wage adjustments, and informs economic policy decisions.

A recession is characterized by a significant decline in economic activity that spreads across the economy and lasts for more than a few months. This decline is determined by a committee of experts at the National Bureau of Economic Research (NBER), a private, nonpartisan organization. The NBER considers several key indicators, including real personal income, nonfarm payroll employment, industrial production, and wholesale-retail sales, to identify recessionary periods. While a common informal definition suggests two consecutive quarters of negative Gross Domestic Product (GDP) growth, the NBER’s determination is based on a broader assessment of economic activity’s depth, diffusion, and duration.

How CPI Typically Behaves During Recessions

During a recession, the Consumer Price Index most commonly exhibits disinflation, a slowdown in its rate of increase. In some instances, prices may even experience deflation, an outright decline. This behavior stems from fundamental economic shifts that occur when economic activity contracts.

A primary reason for this trend is a significant reduction in consumer spending and overall demand. As incomes decline and job security becomes uncertain, individuals tend to postpone discretionary purchases. This decrease in demand leads businesses to face lower sales volumes and accumulated unsold inventory. To encourage sales and maintain cash flow, businesses often resort to discounting prices or holding price levels stable. Historically, inflation rates have fallen in major recessions, such as those experienced in 1929-32, 1981, 1991, and 2020.

Factors Affecting CPI During a Downturn

Reduced consumer demand plays a significant role in putting downward pressure on prices. As incomes decrease and job insecurity rises, households become more cautious with their spending, leading to a broad reduction in demand. This decline compels businesses to offer discounts or avoid price increases to attract customers.

Rising unemployment rates further contribute by directly impacting consumer spending power. When more individuals are out of work, overall purchasing power diminishes, reinforcing downward pressure on prices. High unemployment also suppresses wage growth, as competition for jobs increases, limiting household income and spending.

Prices for raw materials and other commodities frequently fall during recessions. A decrease in global economic activity reduces demand for industrial metals, energy products like oil, and agricultural goods. This leads to lower commodity prices, which translate into lower production costs for businesses, passed on to consumers.

Central banks typically respond to recessions by implementing monetary policy measures aimed at stimulating the economy. Lowering interest rates is a common strategy to encourage borrowing and investment, though the immediate effect during a recession often remains disinflationary due to reduced demand. Supply chain dynamics can also influence prices during a downturn. Disruptions or increased resilience in supply chains affect the availability and cost of goods, as seen during the COVID-19 pandemic.

Variations in CPI Behavior During Recessions

While disinflation or deflation is the typical pattern for the Consumer Price Index during a recession, economic history shows that this behavior is not universal. Other factors can lead to different outcomes, presenting a more complex picture for price stability during economic contractions.

One notable exception to the general trend is a phenomenon known as “stagflation.” Stagflation describes a challenging economic period characterized by a simultaneous occurrence of economic stagnation (slow growth or recession), high unemployment, and rising inflation (an increasing CPI). This scenario challenges traditional economic theories, which often suggest an inverse relationship between inflation and unemployment.

Stagflation typically arises from supply shocks, such as a sudden and significant increase in the price of essential commodities like oil. When the cost of such a fundamental input rises sharply, it increases production costs for businesses across many sectors, which are then passed on to consumers as higher prices. This cost-push inflation occurs even as the economy stagnates or contracts, leading to the unusual combination of rising prices and high unemployment. Misguided government policies, such as those that simultaneously hinder industrial output while rapidly expanding the money supply, can also contribute to stagflation. While less common than demand-driven recessions, these supply-side pressures or policy missteps can result in a CPI that increases even during periods of economic decline.