A recession is a prolonged period of low economic activity that might last months or even years. When a country’s economy faces negative gross domestic product (GDP), growing unemployment, dropping retail sales, and contracting income and manufacturing metrics for a protracted period of time, experts call it a recession. Recessions are an inescapable element of the business cycle, which is the regular cadence of expansion and recession in a country’s economy.
What are the warning signals of impending recession?
A recession is a prolonged period of considerable drop in economic activity in a specific region or across the entire country. This might look like this:
What are the five reasons for a recession?
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 nearly 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 happens at the start of a downturn?
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):
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.
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 long do economic downturns last?
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.
During a recession, what happens to unemployment?
During a recession, unemployment tends to grow quickly and stay high for a long time. As a result of higher costs, stagnant or declining revenue, and greater pressure to cover debts, businesses tend to lay off workers in order to save money. During a recession, the number of jobless workers rises throughout many industries at the same time, newly unemployed workers find it difficult to find new jobs, and the average period of unemployment for workers rises. We’ll look at the link between unemployment and recession in this article.
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.
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.