Following a recession, the economy adjusts and recovers some of the gains that were lost during the downturn. When growth accelerates and GDP begins to move toward a new peak, the economy shifts to a real expansion.
How do countries emerge from a slump?
The majority of mainstream economists believe that recessions are caused by insufficient aggregate demand in the economy, and that expansionary macroeconomic policy should be implemented during recessions. Depending on whatever economic school policymakers follow, several strategies for getting an economy out of a slump are preferred. Monetarists encourage the use of expansionary monetary policy, whereas Keynesian economists may advocate higher government expenditure to stimulate the economy. Tax cuts may be suggested by supply-side economists to encourage company capital investment. When interest rates hit the 0 percent interest rate (zero interest-rate policy), traditional monetary policy can no longer be employed to support recovery, and the government must rely on other measures. When monetary policy fails, Keynesians say that fiscal policytax cuts or increased government spendingworks. Because of the bigger multiplier, spending is more effective, but tax cuts are more immediate.
In December 2010, Paul Krugman wrote that significant, sustained government spending was required because indebted households were paying down debts and were unable to carry the US economy as they had previously: “The debt that American families accumulated during the Bush-era housing bubble is at the root of our current problems…highly indebted Americans can’t spend like they used to, and they’re also having to pay down the debts they accumulated during the bubble years. This might be acceptable if someone else picked up the slack. However, what is truly happening is that some people are spending significantly less while no one is spending more, resulting in a stagnant economy and massive unemployment. In this case, the government should spend more while the private sector spends less, so boosting employment while debts are paid down. And this level of government spending must be maintained…”
What is the most effective strategy for a country to emerge from a recession?
Even once the main reason of the recession has passed, a strong economic recovery is never guaranteed. For most industrialized countries, the decade of the 2010s was a period of lackluster recovery. As the lockdown measures are removed, here are four lessons learned from that decade that will aid in avoiding another delayed recovery.
Avoid collective saving
A person’s money spent is a person’s money earned. If one individual spends more than their income over a period of time (i.e. has a surplus), another must earn more (i.e. run a deficit). Figure 1 depicts the UK private, public, and external sector surpluses and deficits. Each quarter’s bars must add up to zero.
If one sector tries to expand its surplus by lowering spending, another must be ready to either reduce its surplus or increase its deficit by spending more. Otherwise, total revenue falls, wiping off the surplus gain that was planned.
In order to deleverage, the UK private sector began generating huge surpluses in 2008. Initially, these were met by increasing budget deficits. When austerity was implemented in 2011-12, the budget deficit began to decrease. The private sector surplus would be less than ideal unless the rest of the world was willing to cut its surplus. Slower income growth thwarted saving efforts, prolonging private sector deleveraging and causing fiscal deficit reduction targets to be regularly missed.
Countries that delayed austerity until the private sector had recovered fared better. Between 2010 and 2013, the US cut its cyclically adjusted budget deficit by 5.2 percent of GDP, nearly matching Spain’s 6.2 percent of GDP and surpassing the UK’s 3.2 percent. Nonetheless, the United States outperformed Europe. Between 2009 and 2011, the private sector in the United States has deleveraged significantly more than in Europe, with households in the United States shedding debt equivalent to 10% of GDP. Household debt in Spain remained unchanged over the same period, but household debt in the United Kingdom declined by 5% of GDP.
Savings by the public and private sectors continued in southern European countries until the external sector became surplus. Because currency depreciation was not an option, this realignment was brutally achieved with modest income growth, which kept imports and wages low. From 2011 to 2015, Spain’s imports remained unchanged, while wages did not begin to climb until 2018.
Help the private sector deleverage
Domestic demand quickly recovered in countries that immediately reduced family debt. Non-recourse mortgages, which are tied to the property and do not follow the mortgage holder after foreclosure, allowed US households to shake off debt.
In the United States, a mortgage holder can pay off their debt and start over; in Spain, a mortgage holder can be saddled with unmanageable debt for years. In the long run, this is bad for banks since it affects consumer spending and the larger economy, raising non-performing loans and lowering credit demand. One method to get around this is to change the laws. Allowing inflation to run high for a short time can also help the private sector deleverage by rising money incomes compared to money debts.
Go slow on bank recapitalisation
Regulators in several jurisdictions have enabled banks to deplete their capital buffers. Demand will be supported by gradually rebuilding these buffers during the recovery. Banks can boost their capital ratio by raising capital or reducing risk-weighted assets, which in practice means cutting back on business lending. Figure 2 depicts the gradual recovery of bank lending following the past recession. It was strongest in the United States, where less rigorous regulations were enacted.
Keep an eye on broad money
Predictions of out-of-control inflation failed to materialize in the 2010s. The forecasts tended to be based on the large expansion of central bank balance sheets, whereas commercial bank balance sheets proved to be a better predictor to inflation (and aggregate demand). The majority of money nowadays is in the form of electronic deposits, which are commercial bank obligations. Figure 2 depicts the evolution of M2 in the United States, which includes bank deposits, during the last decade. It is possible to develop better measures, but this is the most timely.
M2 has grown at a rate of 16 percent every year. Inflation is currently more likely than it was in the 2010s, although it is still not guaranteed. Much of this will be firms borrowing to boost their cash reserves in order to get through challenging times; rather than exceeding demand, the supply of cash is expanding to meet it. Higher money growth rates, on the other hand, may be on the way as a result of increased government bond issuance, which leads broad money to rise.
When does a recession usually come to an end?
That is an excellent question. Unfortunately, there isn’t a standard answer, however there is a well-known joke about the difference between the two that economists like to tell. But we’ll return to that eventually.
Let’s start with a definition of recession. As previously stated, there are various widely accepted definitions of arecession. Journalists, for example, frequently define a recession as two consecutive quarters of real (inflation adjusted) gross domestic product losses (GDP).
Economists have different definitions. Economists use the National Bureau of Economic Research’s (NBER) monthly business cycle peaks and troughs to identify periods of expansion and recession. Starting with the December 1854 trough, the NBER website tracks the peaks and troughs in economic activity. A recession, according to the website, is defined as:
A recession is a widespread drop in economic activity that lasts more than a few months and is manifested in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins when the economy reaches its peak of activity and concludes when it hits its lowest point. The economy is expanding between the trough and the peak. The natural state of the economy is expansion; most recessions are temporary, and they have been uncommon in recent decades.
While there is no universally accepted definition for depression, it is generally said to as a more severe form of recession. Gregory Mankiw (Mankiw 2003) distinguishes between the two in his popular intermediate macroeconomics textbook:
Real GDP declines on a regular basis, the most striking example being in the early 1930s. If the period is moderate, it is referred to as a recession; if it is more severe, it is referred to as a depression.
As Mankiw pointed out, the Great Depression was possibly the most famous economic slump in US (and world) history, spanning at least through the 1930s and into the early 1940s, a period that actually contains two severe economic downturns. Using NBER business cycle dates, the Great Depression’s first slump began in August 1929 and lasted 43 months, until March 1933, significantly longer than any other contraction in the twentieth century. The economy then expanded for 21 months, from March 1933 to May 1937, before experiencing another dip, this time for 13 months, from May 1937 to June 1938.
Examining the annual growth rates of real GDP from 1930 to 2006 is a quick way to highlight the differences in the severity of economic contractions associated with recessions (in chained year 2000dollars). The economy’s annual growth or decrease is depicted in Chart 1. The gray bars show recessions identified by the National Bureau of Economic Research. The Great Depression of the 1930s saw the two most severe contractions in output (excluding the post-World War II adjustment from 1945 to 1947).
In a lecture at Washington & Lee University on March 2, 2004, then-Governor and current Fed Chairman Ben Bernanke contrasted the severity of the Great Depression’s initial slump with the most severe post-World War II recession of 1973-1975. The distinctions are striking:
Between 1929 and 1933, when the Depression was at its worst, real output in the United States plummeted by over 30%. According to retroactive research, the unemployment rate grew from roughly 3% to nearly 25% during this time period, and many of those fortunate enough to have a job were only able to work part-time. For example, between 1973 and 1975, in what was likely the most severe post-World War II U.S. recession, real output declined 3.4 percent and the unemployment rate soared from around 4% to around 9%. A steep deflationprices fell at a rate of about 10% per year in the early 1930sas well as a plunging stock market, widespread bank failures, and a spate of defaults and bankruptcies by businesses and households were all aspects of the 1929-33 fall. After Franklin D. Roosevelt’s inauguration in March 1933, the economy recovered, but unemployment remained in double digits for the rest of the decade, with full recovery coming only with the outbreak of World War II. Furthermore, as I will show later, the Depression was global in scale, affecting almost every country on the planet, not just the United States.
While it is clear from the preceding discussion that recessions and depressions are serious matters, some economists have suggested that there is another, more casual approach to describe the difference between a recession and a depression (recall that I promised a joke at the start of this answer):
In a recession, what does a country do?
During a recession, the economy suffers, individuals lose their jobs, businesses make less sales, and the country’s overall economic output plummets. The point at which the economy officially enters a recession is determined by a number of factors.
In 1974, economist Julius Shiskin devised a set of guidelines for defining a recession: The most popular was two quarters of decreasing GDP in a row. According to Shiskin, a healthy economy expands over time, therefore two quarters of declining output indicates major underlying issues. Over time, this concept of a recession became widely accepted.
The National Bureau of Economic Research (NBER) is widely regarded as the authority on when recessions in the United States begin and conclude. “A major fall in economic activity distributed across the economy, lasting more than a few months, generally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales,” according to the NBER’s definition of a recession.
Shiskin’s approach for deciding what constitutes a recession is more rigid than the NBER’s definition. The coronavirus, for example, might cause a W-shaped recession, in which the economy declines one quarter, grows for a quarter, and then drops again in the future. According to Shiskin’s guidelines, this is not a recession, although it could be according to the NBER’s definition.
What causes a downturn?
A lack of company and consumer confidence causes economic recessions. Demand falls when confidence falls. A recession occurs when continuous economic expansion reaches its peak, reverses, and becomes continuous economic contraction.
Lower Prices
Houses tend to stay on the market longer during a recession because there are fewer purchasers. As a result, sellers are more likely to reduce their listing prices in order to make their home easier to sell. You might even strike it rich by purchasing a home at an auction.
Lower Mortgage Rates
During a recession, the Federal Reserve usually reduces interest rates to stimulate the economy. As a result, institutions, particularly mortgage lenders, are decreasing their rates. You will pay less for your property over time if you have a lower mortgage rate. It might be a considerable savings depending on how low the rate drops.
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.
What are the two most serious issues that come with a recession?
Readers’ Question: Identify and explain economic elements that may be negatively impacted by the current economic downturn.
- Output is decreasing. There will be less production, resulting in reduced real GDP and average earnings. Wages tend to rise at a considerably slower pace, if at all.
- Unemployment. The most serious consequence of a recession is an increase in cyclical unemployment. Because businesses are producing less, they are employing fewer people, resulting in an increase in unemployment.
- Borrowing by the government is increasing. Government finances tend to deteriorate during a recession. Because of the greater unemployment rate, people pay fewer taxes and have to spend more on unemployment benefits. Markets may become concerned about the level of government borrowing as a result of this deterioration in government finances, leading to higher interest rates. This increase in bond yields may put pressure on governments to cut spending and raise taxes to reduce budget deficits. This could exacerbate the recession and make it more difficult to recover. This was especially problematic for many Eurozone economies during the recession of 2009. See also the Eurozone budgetary crisis.
- Depreciation of the currency.
- In a recession, currencies tend to depreciate because consumers predict reduced interest rates, so there is less demand for the currency. However, if there is a worldwide recession that affects all countries, this may not happen.
- Hysteresis. This is the claim that a rise in cyclical (temporary) unemployment can lead to a rise in structural (long-term) unemployment. During a recession, someone who has been unemployed for a year may become less employable (e.g. lose on the job training, e.t.c) See hysteresis for more information.
- Asset prices are declining. There is less demand for fixed assets such as housing during a recession. House price declines might exacerbate consumer spending declines and raise bank losses. A balance sheet recession (such as the one that occurred in 2009-10) is characterized by a drop in asset prices. Balance sheet recession is a term used to describe a period in which a company’s financial
- Rising unemployment has resulted in social difficulties, such as increasing rates of social isolation.
- Inequality has risen. A recession tends to exacerbate wealth disparities and poverty. Unemployment (and the reliance on unemployment benefits) is one of the most common causes of relative poverty.
- Protectionism is on the rise. Countries are frequently encouraged to respond to a global downturn with protectionist measures (e.g. raising import duties). This results in retaliation and a general fall in commerce, both of which have negative consequences.
Evaluation can recessions be beneficial?
- Some economists believe that a recession is required to address inflation. For example, the recessions of 1980 and 1991/92 in the United Kingdom.
- Recessions can encourage businesses to become more efficient, and the ‘creative destruction’ of a downturn can allow for the emergence of new businesses.
These factors, however, do not outweigh the recession’s significant personal and social costs.
US house prices
House prices decreased just before the recession began in 2006, and declining house prices contributed to the recession’s onset. However, as the recession began, property prices plummeted much worse.
Great Depression 1929-32
The Great Depression was a significantly more severe downturn, with output dropping by more than 26% in three years.
It resulted in a substantially greater rate of unemployment, which increased from 0% to 25% in just two years.