Recession can be defined as the contraction of a business or economic cycle when a general decline in economic activity lasts for months or even years and it also a significant decline in general economic activity in a particular region. During recession economy experiences the negative gross domestic product (GDP), rising levels of unemployment, falling retail sales and contracting measures of income and manufacturing for an extended period of time. It can affect natural business and economic cycle of expansion and contraction. Although an economy can show signs of weakening months before a recession begins, the process of determining whether a country is in a true recession may not often take time. A recession is short, but its impact can be long-lasting.
In this article we will look in depth what exactly is a recession, how does it start, and what typically happens in recession?
What causes recession?
There are many reasons for the occurrence of recession. Some of the recessions are merged with sharp changes in prices, which lead to a steep fall in private and public sector spending. It usually takes place when a decline in confidence, a feeling among businesses and consumers that time will not be as good as it used to be.
Leading indicators such as reduced working hours, lower new orders of capital and consumer goods and lower building permits will all trigger a recession. An economy begins to expand in its tank (weak point) and begins to regress after reaching its peak (high point). A deep recession that lasts for a long time will eventually turn into depression.
The recent recession COVID-19 recession is the global economic recession caused by the COVID-19 pandemic, which began in February 2020, is the worst global economic crisis since the Great depression 1930. Stock markets and consumer activity stagnated after a year of global recession, with the Covid-19 lockdowns and other precautions taken in early 2020 pushing the global economy into crisis. Within seven months, every advanced economy had fallen into recession or depression, while all emerging economies were in recession. World Bank modeling suggests that in some regions the recovery will not be achieved until 2025 or beyond.
- A financial crisis – If banks have a shortage of liquidity, they reduce lending and reduces investment.
- High Interest rates – Interest rates limits the liquidity money that’s available to invest when they rise. While hiking interest rates increases the cost of borrowing and reduces demand. For Example: While recession, the Fed has often raised interest rates to protect the value of the dollar.
- Fall in asset prices – A sudden loss of confidence in investing can create a subsequent bear market, draining capital out of businesses. Negative wealth effect leads to less spending.
- Fall in real wages and Consumer Confidence – The real preferences of consumers, savers, and investors place limits on how far such an artificially stimulated boom can proceed. These manifest as real economic constraints on continued growth, in the form of labor market shortages, supply chain bottlenecks, and spikes in commodity prices (which lead to inflation) when not enough real resources can be made available to support all the over stimulated business investment plans based on easy-money policies. Once these set in, a rash of business failures begins in the face of increased production costs and the economy tips into recession.
- Excess inflation and deflation – Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation. Example: Japan’s struggles with deflation throughout most of the 1990s caused a severe recession.
- Trade war – During a recession asset prices typically plummet. The markets can be volatile with asset prices experiencing wild swings. Investors react quickly to any hint of news either good or bad and the flight to safety can cause some investors to pull their money out of the assets entirely.
Recessions versus Depressions
Economists estimate that there have been 33 recessions in the United States since 1854. Since the 1980s, there have been four periods of negative economic growth that are considered recessions. Well-known examples of the recession include the 2008 financial crisis and the global recession in the wake of the Great Depression of the 1930s. Depression is a deep and chronic depression.
While there are no specific criteria for declaring depression, the distinctive features of the Great Recession are that GDP fell more than 10% and the unemployment rate briefly touched 25%. Ideally, a depression is a severe decline that lasts for years.
The economic recession can be disaster for any country. This will lead to the closure of many companies, increase the unemployment rate and slow economic growth. But even when an economy is in recession, people do not have integrated views. The central bank should consider the implications of implementing monetary policy. It should take into account both the promotion of economic growth and the control of inflation. Sometimes economy forecasting is uncertain, predicting future recessions is far from easy. For example recent recession COVID-19 appeared seemingly out of nowhere in early 2020, and within a few months the U.S. economy had been all closed down and millions of workers had lost their jobs. The NBER has officially declared a U.S. recession due to coronavirus, noting that the U.S. economy fell into contraction starting in February 2020.
Some people believe that the recession is the best time to start a new business. As unemployment rises, labor becomes cheaper, and for those who can afford it, money may be available. Depression is a severe recession, the duration of which is usually measured in years rather than months. Depression can also involve the breakdown of a key part of the economy, especially the financial system.
