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Brimmer (1980) defines inflation as a rise in the universal level of prices of commodities and services in given economy for a period of time. As the level of prices rise, every unit of currency buys fewer commodities and services. As a result, inflation is as well an erosion agent in the buying ability of money, which is a loss of actual worth in the internal medium of exchange and acts as a building block of account in the economy. Inflation rate becomes the main measure of price inflation. It is given as a yearly percentage change in a universal price index for a given time.
The current annual inflation rate in USA is 1%. Inflation brings about varied effects on an economy and these effects can possibly have positive and negative impacts on the economy simultaneously. Negative effects of inflation comprise of a decrease in the actual worth of money over time, the uncertainty of inflation in the future may deter savings and investment, and increased inflation may result into shortfalls of goods as consumers start hoarding motivated by the fear that prices will rise in the future. Positive effects comprise of a moderation of economic depressions, and debt alleviation by cutting down the actual level of debt (Thoma, 2010).
Das (1993) defines an economic recession as a business cycle condensation, a general retardation in economic activity in a given time period. For the period of recessions, various macroeconomic indicators change in a similar manner. Employment, production as measured by Gross Domestic Product (GDP), spending in investment, household incomes, capacity utilization, inflation, and business profits come down during recessions; and on the other hand the unemployment rate and bankruptcies rise. Recessions are usually conceived to be brought about by a widespread drop in disbursal of money. Governments generally react to recessions by putting in place expansionary macroeconomic policies, for instance increasing the supply of money, increasing government expenditure and diminishing taxation.
In the United States, a vicious cycle is presently in progress, and its attainment could widen to the worldwide economy. America's economic crisis has activated a terrible liquidity crisis that is worsening the U.S. recession, while the thickening recession is resulting into bigger losses in fiscal markets, therefore weakening the broader economy. Currently there is a serious jeopardy of a total meltdown in US fiscal markets as vast asset and credit bubbles prostration. Because of these, the debate in the U.S. is no more concerning soft landing against hard landing; it is instead on how hard the hard landing will take place. It is clear that the economy of USA has already come into a recession in December 2007. One of the major results of inflation is to the worker in American. The first discouraging impact is a user's shopping patterns and sum of money spent on buying goods and services. Inflation makes consumers to move the timing of their shopping nearer to the reception of income and makes inducements for owners of shops to diminish their inventories.
Thoma (2010) makes it clear that the US economy has been extremely weak and having a negative growth in the second quarter of the year 2008. In this year the housing market continued being oversupplied and residential construction kept on to plunging at steeper rates with house prices going down. Private consumption diminished significantly in the beginning of the year 2008 as increased inflation, determined by food and gasoline prices, hence diminishing the purchasing ability for consumers, tauter credit starts to bite and reducing house prices weighed down households' collateral and wealth. The business investment, which started slowing down in the year 2007, slumped in the first quarter of the year 2008, depicting the declining of real and potential demand. Contrary, exports have stayed comparatively strong, gaining from dollar's reduction in value and until now strong global trade growth. Together with the restrained imports, this has resulted into a substantial collapse of the US current account shortfall to immediately below 5% of GDP by the end of the year 2007.
The Federal Reserve uses open market operations as a tool for holding over the supply of credit and currency in the economy. Open market operations are concerned with the buying and selling of government securities. To ensure increased supply of money, the Federal Reserve buys government securities from banks, individuals, as well as other businesses, paying for them in terms of a check. So that there is a reduced money supply in the economy, the Federal Reserve sells government securities to banks, hoarding reserves from them. Because they have lower reserves, banks must cut down their lending, and the money supply drops consequently. This in turn reduces inflation in the economy (Hafer, 2005).
The Federal Reserve can as well control the money supply by determining the reserves deposit that the taking institutions must allow either in terms of currency inside their vaults or in terms of deposits within their regional reserve Banks. So that to reduce money supply to combat inflation, the Federal Reserve raises reserve demands hence forcing banks to keep back a bigger portion of their money. Banks frequently lend each other money as loans to ensure they meet their reserve demands. The rate on these loans, usually referred to as federal funds rate, is the central measure of how loose or tight monetary policy is at a particular time. Tight money policy ensures reduced inflation in the economy (Thoma, 2010).
According to Hafer (2005), the USA Congress needs to make a decision on what the mandate of Federal Reserve is and to what extent the Fed is independent to pursue it. The USA Congress is then supposed to honor whatever extent of independence which the Fed has been accorded, particularly for the period of crisis during which the Fed may be squeezed to do unusual things it believes are most beneficial from a long-term perspective.