In general, an economy’s expansion and growth cannot persist indefinitely. A complex, interwoven set of circumstances usually triggers a large drop in economic activity, including:
Shocks to the economy. A natural disaster or a terrorist attack are examples of unanticipated events that create broad economic disruption. The recent COVID-19 epidemic is the most recent example.
Consumer confidence is eroding. When customers are concerned about the state of the economy, they cut back on their spending and save what they can. Because consumer spending accounts for about 70% of GDP, the entire economy could suffer a significant slowdown.
Interest rates are extremely high. Consumers can’t afford to buy houses, vehicles, or other significant purchases because of high borrowing rates. Because the cost of financing is too high, businesses cut back on their spending and expansion ambitions. The economy is contracting.
Deflation. Deflation is the polar opposite of inflation, in which product and asset prices decline due to a significant drop in demand. Prices fall when demand falls, as sellers strive to entice buyers. People postpone purchases in order to wait for reduced prices, resulting in a vicious loop of slowing economic activity and rising unemployment.
Bubbles in the stock market. In an asset bubble, prices of items such as tech stocks during the dot-com era or real estate prior to the Great Recession skyrocket because buyers anticipate they will continue to grow indefinitely. But then the bubble breaks, people lose their phony assets, and dread sets in. As a result, individuals and businesses cut back on spending, resulting in a recession.
What does a recession imply?
A recession is a macroeconomic phrase that denotes a considerable drop in overall economic activity in a specific area. It was previously defined as two consecutive quarters of economic contraction, as measured by GDP and monthly indicators such as an increase in unemployment. The National Bureau of Economic Research (NBER), which officially declares recessions, claims that two consecutive quarters of real GDP drop are no longer considered a recession. A recession, according to the NBER, is a major drop in economic activity across the economy that lasts longer than a few months and is reflected in real GDP, real income, employment, industrial production, and wholesale-retail sales.
What is recession and what are its consequences?
High unemployment, falling average earnings, greater inequality, and increased government borrowing are all hallmarks of a recession (a drop in national income). The severity of a recession is determined by how long it lasts and how deep the drop in output is.
Who is most affected by a recession?
Those who lose their jobs or have their hours/self-employed income drastically reduced will be the hardest hit.
It also relies on the type of recession that is occurring. The financial industry was the hardest damaged by the recession of 2009. Many well-paid ‘white-collar’ employees were laid off. Large-scale losses and earnings declines were experienced by banks. It had a significant impact on the housing market. The recession of 2020 will be different. The Coronavirus will have an especially negative impact on low-wage workers in the leisure and tourism industry. It will also depend on whether the worker is able to work from home (as a writer) or has a job in the physical economy, which would be hit harder. (For example, selling coffee) The impact will also be determined by the level of government assistance and whether or not they are eligible for benefits or rent relief.
Unemployment
Unemployment in the UK grew to almost 2.6 million during the recession of 2009, yet considering the severity of the recession, you might have anticipated it to be even higher (e.g. in the 1980s, unemployment rose to over 3 million). However, unemployment in several European countries has skyrocketed. Countries like Greece, Spain, and Portugal have over 20% unemployment rates.
Unemployment estimates could be understating the genuine degree of unemployment. In a recession, for example, the self-employed may face a significant drop in income yet are not considered unemployed.
Unemployment soared from 0% to 25% in three years during the Great Depression, when GDP fell rapidly.
Lower wages
In a downturn, businesses will aim to save expenses by keeping wages low. Some workers (particularly contract workers) may face wage decreases. This was a major element of the 2008-12 recession, which was exacerbated by rising living costs (e.g. higher taxes/oil prices). At the very least, cost-push inflation will be low in 2020, thanks to lower oil and commodity prices.
Underemployment is another factor that contributes to lower pay. Some employees may keep their jobs, but their hours will be reduced. Rather than working full-time, they choose to work part-time (e.g. 20 hours a week). As a result, while the growth in unemployment may be limited, many workers may face significant drops in effective income.
Self-employed people are particularly sensitive to economic downturns. During a downturn, self-employed people may experience a cash-flow shortage immediately and struggle to make ends meet.
Higher government borrowing
- As a result of the lower profit margins, the government receives lower corporate tax revenue.
- Stamp duty revenue is reduced due to decreasing house prices and fewer housing transactions.
- Government spending on social benefits, such as unemployment benefits, housing assistance, and income support, is on the rise.
A recession tends to raise the budget deficit and overall government debt due to decreased tax receipts and rising welfare payments (automatic fiscal stabilisers).
Following the crisis of 2008/09, the US budget deficit increased dramatically. The estimate for 2021 is incorrect. Borrowing in the United States will increase in 2021 as a result of the Coronavirus and the impending recession.
Because they rely on property and banking sector tax receipts, many countries saw their budget deficits skyrocket following the 2008 credit crisis. The property market’s decline had a greater impact on tax revenues. VAT receipts have a lower cyclicality.
A budget deficit may also rise as a result of the government’s decision to adopt an expansionary fiscal policy in order to boost economic growth. The UK government, for example, reduced VAT in 2010.
Falling asset prices
Because demand declines during a worldwide recession, oil prices tend to fall. The 2020 Coronavirus resulted in a significant decline in oil prices as well as a drastic collapse in stock prices. It’s a measure of how much the recession is expected to hurt, according to analysts. The economy’s downward spiral is aided by falling asset prices. House prices falling produce a negative wealth effect, lowering confidence and encouraging more spending cuts. In 2020, we are expected to see a decrease in housing prices.
Bond Yields
Government bond yields usually decline during a recession. This is because, during a recession, people tend to save more and choose the safety of bonds over the stock market. Bond rates in the United States have plummeted to near-record lows in 2020. The yield on a two-year US Treasury bill is 0.46 percent.
If markets believe that the recession will pose major issues for the government and a liquidity shortfall, bond yields may climb. For example, due to genuine concerns about the Italian economy collapsing, Italian bond yields began to rise in 2020. Much will be determined by the ECB’s reaction and whether or not they will generate money to supply liquidity.
Lost Output
A recession causes lower investment, which might harm the economy’s long-term productive capability. If the recession is brief, the amount of lost output may be minimal economies can recover. However, in a prolonged recession, the amount of lost output increases. Because of the depth of the recession and structural deficiencies, the 2009 recession resulted in a permanent loss of output.
Impact on Workers
Unemployment can have long-term consequences. To begin with, unemployment is extremely stressful and can negatively impact a person’s morale and even health. Areas with significant unemployment have a higher rate of social problems. High unemployment can contribute to social unrest, resulting in issues such as rioting and vandalism. Unemployment in large numbers might jeopardize a country’s social fabric.
Unemployed people miss out on opportunities to learn new skills and receive on-the-job training. Long-term unemployment might make it more difficult for a worker to find work in the future; it can even lead to people giving up and leaving the labor market entirely.
Unemployment and recession can lead to an increase in social/health issues including depression and suicide.
Impact on firms
Demand will decline, resulting in lower profitability for businesses. Some businesses may begin to lose money and eventually go out of business. This could be due to intrinsic inefficiency, but it could also be owing to cyclical causes, such as an inability to borrow enough money to make it through the recession. Some businesses will be hurt harder than others during a recession. In a recession, demand for luxury items (international vacations) and high-end sports automobiles plummets, making these companies more vulnerable.
If a corporation has sufficient reserves, it will be able to weather the storm, even if it suffers a temporary loss. Price wars and cost-cutting may be pursued by a company during a recession.
- Firms frequently engage in price wars in order to maintain market share. As a result, drastic price cuts are implemented, substantially reducing the company’s profitability.
- Companies will be obliged to look closely at decreasing expenses and maybe eliminating unproductive portions of the business as a result of declining profitability. Companies may be forced to lay off employees in order to cut costs.
Are there any potential positive effects of a recession?
- The collapse of Chinese manufacturing in early 2020 resulted in a significant reduction in air pollution, which will help to reduce mortality attributable to air pollution.
- Surprisingly, some recessions have been shown to extend life expectancy. During the Great Depression, death rates in the United States declined in places where there was a lot of unemployment. People spent less money on alcohol and cigarettes, both of which are harmful to one’s health. In addition, there has been a decrease in traffic accidents. (NPR – Lower mortality rates due to the Great Recession)
What happens when there is a recession?
- A recession is a period of economic contraction during which businesses experience lower demand and lose money.
- Companies begin laying off people in order to decrease costs and halt losses, resulting in rising unemployment rates.
- Re-employing individuals in new positions is a time-consuming and flexible process that faces certain specific problems due to the nature of labor markets and recessionary situations.
What is the duration of a recession?
A recession is a long-term economic downturn that affects a large number of people. A depression is a longer-term, more severe slump. Since 1854, there have been 33 recessions. 1 Recessions have lasted an average of 11 months since 1945.
In a downturn, who benefits?
Question from the audience: Identify and explain economic variables that may be positively affected by the economic slowdown.
A recession is a time in which the economy grows at a negative rate. It’s a time of rising unemployment, lower salaries, and increased government debt. It usually results in financial costs.
- Companies that provide low-cost entertainment. Bookmakers and publicans are thought to do well during a recession because individuals want to ‘drink their sorrows away’ with little bets and becoming intoxicated. (However, research suggest that life expectancy increases during recessions, contradicting this old wives tale.) Demand for online-streaming and online entertainment is projected to increase during the 2020 Coronavirus recession.
- Companies that are suffering with bankruptcies and income loss. Pawnbrokers and companies that sell pay day loans, for example people in need of money turn to loan sharks.
- Companies that sell substandard goods. (items whose demand increases as income decreases) e.g. value goods, second-hand retailers, etc. Some businesses, such as supermarkets, will be unaffected by the recession. People will reduce their spending on luxuries, but not on food.
- Longer-term efficiency gains Some economists suggest that a recession can help the economy become more productive in the long run. A recession is a shock, and inefficient businesses may go out of business, but it also allows for the emergence of new businesses. It’s what Joseph Schumpeter dubbed “creative destruction” the idea that when some enterprises fail, new inventive businesses can emerge and develop.
- It’s worth noting that in a downturn, solid, efficient businesses can be put out of business due to cash difficulties and a temporary decline in revenue. It is not true that all businesses that close down are inefficient. Furthermore, the loss of enterprises entails the loss of experience and knowledge.
- Falling asset values can make purchasing a home more affordable. For first-time purchasers, this is a good option. It has the potential to aid in the reduction of wealth disparities.
- It is possible that one’s life expectancy will increase. According to studies from the Great Depression, life expectancy increased in areas where unemployment increased. This may seem counterintuitive, but the idea is that unemployed people will spend less money on alcohol and drugs, resulting in improved health. They may do fewer car trips and hence have a lower risk of being involved in fatal car accidents. NPR
The rate of inflation tends to reduce during a recession. Because unemployment rises, wage inflation is moderated. Firms also respond to decreased demand by lowering prices.
Those on fixed incomes or who have cash savings may profit from the decrease in inflation. It may also aid in the reduction of long-term inflationary pressures. For example, the 1980/81 recession helped to bring inflation down from 1970s highs.
After the Lawson boom and double-digit inflation, the 1991 Recession struck.
Efficiency increase?
It has been suggested that a recession encourages businesses to become more efficient or go out of business. A recession might hasten the ‘creative destruction’ process. Where inefficient businesses fail, efficient businesses thrive.
Covid Recession 2020
The Covid-19 epidemic was to blame for the terrible recession of 2020. Some industries were particularly heavily damaged by the recession (leisure, travel, tourism, bingo halls). However, several businesses benefited greatly from the Covid-recession. We shifted to online delivery when consumers stopped going to the high street and shopping malls. Online behemoths like Amazon saw a big boost in sales. For example, Amazon’s market capitalisation increased by $570 billion in the first seven months of 2020, owing to strong sales growth (Forbes).
Profitability hasn’t kept pace with Amazon’s surge in sales. Because necessities like toilet paper have a low profit margin, profit growth has been restrained. Amazon has taken the uncommon step of reducing demand at times. They also experienced additional costs as a result of Covid, such as paying for overtime and dealing with Covid outbreaks in their warehouses. However, due to increased demand for online streaming, Amazon saw fast development in its cloud computing networks. These are the more profitable areas of the business.
Apple, Google, and Facebook all had significant revenue and profit growth during an era when companies with a strong online presence benefited.
The current recession is unique in that there are more huge winners and losers than ever before. It all depends on how the virus’s dynamics effect the firm as well as aggregate demand.
How do you get through a downturn?
But, according to Tara Sinclair, an economics professor at George Washington University and a senior fellow at Indeed’s Hiring Lab, one of the finest investments you can make to recession-proof your life is obtaining an education. Those with a bachelor’s degree or higher have a substantially lower unemployment rate than those with a high school diploma or less during recessions.
“Education is always being emphasized by economists,” Sinclair argues. “Even if you can’t build up a financial cushion, focusing on ensuring that you have some training and abilities that are broadly applicable is quite important.”
How can we avoid a downturn?
A recession is defined as a drop in real GDP or a period of negative economic growth. To avoid a recession, the government and the central bank must endeavor to boost aggregate demand (consumer spending, investment, exports). They can’t promise that they’ll function. It will be determined by the policies implemented as well as the reasons of the recession.
- Monetary policy loosening interest rates are decreased to lower borrowing costs and boost investment.
- Expansionary fiscal policy – higher government expenditure supported by borrowing will allow investment into the circular flow to be injected.
- Ensure financial stability – in the event of a credit crunch, government involvement to guarantee bank deposits and key financial institutions can help the banking sector maintain credibility.
If very high interest rates are causing the recession, then lowering interest rates may help avoid one. However, if asset prices fall sharply and banks lose money (a situation known as a balance sheet recession), it becomes more difficult since banks may refuse to lend even if interest rates are decreased.
Policies to avoid a Recession
1. Monetary policy that is expansionary interest rates are being lowered. Interest rates being cut should assist improve aggregate demand. Lower interest rates, for example, cut mortgage interest payments, leaving customers with more disposable cash. Interest rates that are lower encourage businesses and people to spend rather than save. (as a result of the decreased interest rates)
The monetary authorities could strive to lower other interest rates throughout the economy in addition to decreasing base rates. The Central Bank, for example, could purchase government bonds or mortgage securities. Purchasing these bonds lowers interest rates and stimulates economic spending.
Lower interest rates, on the other hand, do not always work. Interest rates in the UK were slashed to 0.5 percent in 2008-09, but the country still experienced a recession. This was due to the following:
- Despite low loan rates, banks were hesitant to lend and consumers were hesitant to spend.
2. Easing quantitatively If interest rates are already at zero, the Central Bank may be forced to adopt unconventional monetary policies. Quantitative easing entails the central bank producing money electronically and using it to purchase long-term securities. This boosts bank reserves, which should help banks lend more. It also lowers bond interest rates, which should boost consumption and investment. See also: What Is Quantitative Easing?
3. Money in the form of a helicopter. Helicopter money is a policy that aims to expand the money supply by giving money to consumers directly. This works well in a deflationary environment, where people are hesitant to spend and banks are hesitant to lend money. See also: Helicopter cash
4. Fiscal policy that is expansionary
Increased government expenditure and/or tax cuts are examples of expansionary fiscal policy. Government borrowing is used to fund this infusion into the circular flow. When the government lowers income taxes or the VAT, it boosts disposable income and thus spending.
If fiscal and monetary policy are both effective, AD will rise, resulting in an increase in real GDP.
- If confidence is low, there is no certainty that tax cuts will raise expenditure. Some economists worry that increased government borrowing will lead to crowding out, in which the private sector lends to the government but subsequently spends less. In a recession, however, there will be surplus savings, so there will be no crowding out, and fiscal policy will be helpful in boosting demand and preventing a recession, according to Keynes. Is it possible to avoid a recession by lowering taxes?
- Expansionary fiscal policy is less feasible for Eurozone countries, which have less flexibility over borrowing levels.
5. Maintain financial security. During the 2008 credit crisis, there was a risk that savers might lose faith in bank savings. Customers were forming lines to withdraw their funds. If individuals lose faith in the financial system, it could result in bank closures, a quick drop in trust, and a reduction in the money supply (like the US in 1932). As a result, the Central Bank/government serves as a lender of last resort, ensuring savings. Bank losses and a drop in consumer spending might result from home repossessions.
The government may try to avoid home repossession by freezing mortgage rates or providing subsidies to households facing foreclosure.
6. Depreciation. A rise in aggregate demand can be triggered by a depreciation in the currency rate. Exports become cheaper and imports become more expensive as the value of the dollar falls, increasing domestic demand. (See: Devaluation Effects)
When the UK abolished the Gold Standard in 1932, the Pound fell, allowing the UK economy to recover faster than other countries during the Great Depression.
In a worldwide recession, however, export demand may be highly inelastic. In a global recession, countries may also seek to devalue their currencies in order to remain competitive. This occurs when a group of countries seeks to obtain a competitive edge by depreciating their currencies against those of other countries, but it is self-defeating.
7. Aim for a higher inflation rate. This is a deliberate choice to focus on growth rather than inflation. The premise is that if the economy is locked in a low-inflation phase, it will result in slower economic growth. Breaking out of a deflationary spiral requires aiming for a higher inflation rate. See also: Inflation target that is optimal.
8. A bailout of major corporations by the government. The Obama government agreed to bail out the US automobile sector in 2009, when it was facing financial difficulties. The argument was that closing the automotive sector would worsen the recession, increase unemployment, and have a large negative multiplier effect. The bailout saved employment and kept the economy from collapsing.
In actuality, it is extremely impossible for a government or central bank to avoid recessions all of the time. If the global economic outlook is bleak, monetary and fiscal policy may not be sufficient. In addition, there are considerable temporal gaps in the policies. However, the appropriate mix of fiscal and monetary policy can at the very least limit the slump and hasten the recovery. Other policies, such as, may be suitable depending on the economic situation.
What are the early warning signals of a downturn?
Real gross domestic product (GDP), or goods produced minus inflationary impacts, is the economic measure that most clearly identifies a recession. Income, employment, manufacturing, and wholesale retail sales are some of the other major indicators. Each of these areas suffers a drop during a recession.
In a recession, who gets affected?
Rising unemployment, dropping property values, and the stock market decline all had an impact on those approaching retirement, either directly or indirectly. Furthermore, many elderly persons who were not directly impacted by the recession had children or other relatives who were. For many older persons, the recession’s financial difficulties resulted in changes in wealth and spending patterns, as well as physical and mental health issues with long-term effects.