Recession: What it is and causes it?
Recession is one of the major factors that can disrupt the continuous economic growth of a nation. A large-scale, widespread economic downturn that hurts a nation’s economic growth is known as a recession. The standard rule of thumb is that an economy is said to be in a recession if it has a negative GDP for more than two consecutive quarters. However, even though this short period of recession, causes great damage to the country’s economy, as it results in unemployment, leading to increased poverty.
What is a Recession?
While a lot of economists use different formulas and methods for calculating recession, the following is a common rule to calculate recession:
- Retail sales, non-farm payroll, industrial production, and other common indicators are used by economists at the NBER to measure recessions.NBER adds that no particular formula or characterized set of rules can precisely quantify an economic downturn.
- A recession is typically measured by economists using the decline in the economic growth graph and peak growth. Even if a recession lasts only a short amount of time, it can cause significant damage to an economy and take years to recover from. Since unemployment rises during a recession, even the recovery period may resemble a recession.
- Many nations experienced rapid economic growth from 1960 to 2007 as a result of the industrial revolution. However, a report from the International Monetary Fund (IMF) indicates that many economies also experienced a recession during this time, accounting for more than 10% of the total duration. A recession is self-perpetuating because it causes job losses, which lowers consumers’ purchasing power and contributes to a rebound.
After the Great Depression, which lasted from 1929 to 1941, many nations reformed their economic policies. How bad a recession was can only be determined after it has ended, and almost everyone is affected differently. The equity market typically declines before a recession, indicating that one is coming.
What Causes a Recession?
There are numerous theories among economists that can explain why an economy enters a recession. The psychological, economic, financial, or combined factors—some of the most prevalent ones—are the primary focus of these theories.
- Economic Factors: Numerous economists suggest that industrial production and a shift in economic trends, including structural changes, are some of the main factors that can lead to a recession. A recession could result, for instance, from significant price increases in crude oil.
- Financial Factor: Monetary elements like the accumulation of financial risk, the expansion of credit, and the insufficient growth of the money supply, according to many experts, are also significant contributors to the recession.
- Psychological Factors: Psychological factors lead to a recession including being overly enthusiastic and making more investments during economic booms and being deeply pessimistic during recessions.
- Combined Factors: The majority of the time, a recession is the result of several factors working together to cause it.
Recession and Depression
According to the International Monetary Fund (IMF), a recession can cause an economy’s GDP to fall by 2% or up to 5%. On the other hand, depression can last too long and cause a GDP drop of more than 5%. However, depression can’t be defined by a particular set of clearly defined rules. The United States of America (USA) experienced 34 downturns between 1854-1980. Yet, not a single one of them impacted the US economy so severely, as The Great Depression of the early 20s does. Resulting in an all-time high unemployment rate of 25% and an 80% decline in nearly all major stock prices.
What Predicts a Recession?
Although many economists use the yield curve to predict a recession, there is no one right way to do so.
A yield curve simply compares the interest rates of various bonds with comparable values but distinct maturity dates. When the long-term bond interest rates fall below the short-term bond interest rates, the yield curve inverts, indicating a recession. For instance, a bond with a 10-year maturity time will yield more than a bond with a 2-year maturity time because the first bond experiences higher inflation and has an upward yield curve. However, an economy is said to be in a recession when this upward yield begins to sag and becomes inverted.
ISM purchasing managers’ index
A conference board leading economic index and an ISM purchasing managers index are two other factors that can accurately predict a recession.
It’s often believed that the housing sector can prior intimate about the upcoming recession. If there is a continuous drop in home prices for a longer period then it can be said that a recession is about to hit.
Effects of a Recession
A recession hurts an economy, in many ways:
Reduction in Purchasing Power
A recession not only results in a reduction in the purchasing power of the common people but also increases unemployment. The reduction in purchasing power of the people decreases the demand in the market and thus manufacturing companies also limit their production which also leads to decline in the GDP of a nation. However, this decrease in demand due to a reduction in purchasing power also helps an economy to recover from the recession.
High Unemployment Rate
As a recession occurs, companies and businesses start cutting their cost, and the most commonly adopted way of doing it by many companies is laying off employees. However, as the unemployment rate increases, the cash flow in the market reduces, thus helping the economy to recover faster. However on the other hand higher unemployment rate increases poverty and decreases the economic output of the country as well.
Fall in Interest Rates
Short-term interest rates tend to fall rapidly during a recession, however, the long-term doesn’t get much affected but has a significant impact on interest rates as well. In the short term, investments are quite risky and get easily affected by market volatility and recession. Short-term investments are badly affected by inflation and usually require a larger investment and thus come with a higher risk.
A decline in Economic Output
The economic output tends to fall during a recession as the demand falls, and supply also falls, thus companies limit their manufacturing capacities, leading to declining economic output of the nation. Companies start cost-cutting during a recession and limit their production, but still, their condition is not as bad as the luxury industry.
The government usually intervene when the major institutions of the nation such as banks, and other primary business fails. Government usually makes changes in its economic strategies to deal and overcome with the recession. There are also some positive effects for some companies, that predict upcoming recessions and earn a decent profit during a recession.
FAQs on Recession
Q1. What will happen in a recession?
Ans: The economic output of a nation, consumer spending decreases, and the unemployment rate increases at the time of recession.
Q2. What is a recession and why it is bad?
Ans: A significant and continuous decline in the economy of a nation can be termed a recession. It’s considered bad as its results in job losses, loss in short-term investment, and businesses.
Q3. What is the one-liner difference between the Depression and the Recession?
Ans: A recession is a continuous economic downfall of a nation that usually lasts 6 months, while on the hand a depression can last a year or even longer.
Q4. When does a recession begin?
Ans: A recession mainly begins when a nation observes continuous negative economic growth for more than 2 quarters.
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