Recession – Meaning, Causes, Indicators and More

Recession is an economic term. It means a slowdown in economic activities, usually due to a fall in the spending levels. Such a downturn in economic activities generally lasts for a few quarters, and thus impacts the growth of the economy. A fall in GDP and profits, a rise in unemployment are a few indicators of the economy in a recessionary phase.

To overcome such a phase, the government and the central bank adopt loosening monetary policies. The objective is to boost the supply of funds in the economy. The 2008 global recession is the latest example of such a phase.

When is the Economy in Recession?

Generally, a drop in economic activities for two consecutive quarters is what constitutes a recession. NBER (National Bureau of Economic Research), however, disapproves of the two-quarters theory. As per the agency, it usually lasts more than a few months and results in a significant drop in economic activity across the country. Further, NBER, which officially declares recessions, says the impact of this phase impacts industrial production, sales at all levels, real income, employment, and GDP.

Causes of Recession

Several reasons can trigger a recessionary phase in an economy. Some of the major ones are:

Economic Shock

These are unforeseen events that can have a long-lasting financial impact. The economic shock due to the coronavirus is the latest example of a recessionary phase.

Excessive Debt

There may be a scenario when individuals and businesses take too many loans. It could be term either over trading or high leverage. The interest and the principal get big enough for the individuals and companies to pay. It leads to defaults and bankruptcies. And, it impacts the economy substantially when it happens across sectors. One good example of this is the housing bubble that was responsible for the 2008 recession.

Asset Bubbles

These bubbles usually develop when emotions drive the investing decision. What happens is investors get too optimistic about the returns and continue to pump more money. It inflates the value of assets many times its real value. And, when this bubble bursts, it leads to a crash in the stock market and a downfall in other economic activities.  The late 90s dot-com bubble is an excellent example of this.

High Inflation

Mild inflation is not threatening for an economy, but if inflation gets out of control, it could create havoc—a central bank up the interest rates to keep a check on inflation. And, a fact is that high-interest rates slow down economic activities. Excessive inflation in the US in the 1970s is an excellent example of this.

High Deflation

Deflation is the drop in prices over time. Similar to excessive inflation, an out-of-control deflation can also result in a recessionary phase. Deflation leads to a decline in spending levels, and in turn, a drop in prices. It discourages businesses to produce goods and results in a recession. Deflation in Japan in the 1990s is an excellent example of this.

Technological Change

It often happens that any breakthrough technology leads to a loss of jobs. If this phenomenon takes place on a massive scale, it results in a recessionary phase. For example, at the time of the Industrial Revolution, many people lost jobs to labor-saving technological improvements. In the present time, there are worries that the rise of AI and robots could have a similar impact.

Indicators of Recession

As said above, there are many indicators of a recessionary phase. These are:

GDP

It is the most crucial indicator and includes all that businesses and individuals produce. If the GDP growth numbers are negative, it may be a sign of a recession. However, GDP alone is not a good indicator because, at times, a drop in one quarter may accompany a rise in the next. So, we must consider more indicators as well.

Real Income

It is nothing but the income that takes into account inflation. Or, we can say an inflation-adjusted income. A fall in real income usually results in a drop in purchases and demand as well.

Employment

A high level of unemployment at a specific time also indicates the health of the economy.

Recession

Manufacturing

The low manufacturing level in an economy, as measured by the Industrial Production Report, is also a sign of the recessionary period.

Wholesale-Retail Sales

The sales at the wholesale and retail levels give an idea of consumer demand. A fall in demand is a sign of recession.

Monthly GDP Estimates

If the GDP estimates are not optimistic, it should ring a warning bell of a possible recessionary phase.

A point to note is that experts do not regard the stock market as an indicator of a recessionary phase. It is because the stock market moves mostly on expectations. However, a crash in the stock may result in a recessionary phase.

Does it have any Benefit?

The only positive thing about the recessionary period is that it keeps a check on inflation. Thus, the central bank needs to be careful when trying to take the economy out of the recession. They need to do this without triggering inflation.  The central bank makes use of fiscal policy to overcome the recessionary period.

How Long Recessions Last?

The NBER keeps a record of the recessions in the US. It has past data from 1945 to 2009. An analysis of these data reveals that the average recession lasted in the US for eleven months. Further, the data shows that the average length of a recessionary period from 1854 to 1919 was 21.6 months. The US has gone through three recessions in the last 30 years – The Great Recession (December 2007 to June 2009). The Dot Com Recession (March 2001 to November 2001): and The Gulf War Recession (July 1990 to March 1991).

How the Recession Affect You?

A recession could be terrible for the economy, as well as for individuals. It can result in widespread unemployment, and this, in turn, results in a drop in demand. A reduction in consumer demand could force businesses to go bankrupt. Some may also lose their home if they fail to pay a mortgage.

So, you may lose your job if unemployment gets out of control. You may not only lose your current job, but it could get harder to find a job as the overall economic activity is down. If you somehow retain your job, you may see a cut in the benefits or pay. Moreover, the scenario will be such that you won’t be able to negotiate a pay rise.

If you run a business, then you could have to grapple with a drop in consumer demand. You may even go bankrupt if you are unable to pay your expenses.

Besides, your investments may also see a drop. At the time of the recessionary phase, investment is the stocks, properties, bonds, and other assets that could go down significantly. It may impede your retirement plans as well. If you lose a job and are unable to pay home EMI, then you could go homeless also.

Usually, the government does help businesses and individuals during such times. For instance, amid the coronavirus pandemic, the US administration came out with stimulus checks, extended unemployment benefits, and forgettable loans for small businesses.

One thing that gets people going during such times is that, like everything else, the recession also does not last forever. And, when they end, they usually follow a substantial period of economic growth.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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