Explain what happens to inflation during the business cycle. Give an intuitive explanation as to why inflation changes the way it does over the business cycle

Question

What will be an ideal response?

Answer 1

Inflation will rise during an expansion and fall during a recession. Inflation usually rises near the end of an expansion. Recessions consistently lower the inflation rate. The average decline in the inflation rate has been about 2.5 percentage points during U.S. recessions since 1950. The business cycle has this effect on inflation because spending is usually strong during an expansion and firms will find it easier to raise prices. During a recession the opposite is true. Spending by firms and households is weak and firms might not be able to sell their goods if they aggressively raise prices.