A recession is a substantial economic slump that lasts longer than a few quarters and affects the entire economy.
The phrase is usually defined as a period in which the gross domestic product (GDP) falls for two consecutive quarters. In 1974, economist Julius Shiskin popularized this conventional viewpoint.
However, there are a slew of indications that might help decide whether or not we’re in a downturn.
Perhaps a better analogy for how economists define recessions is what Supreme Court Justice Potter Stewart famously said about his opinion on obscenity: Economists know it when they see it.
The National Bureau of Economic Research (NBER) a private, nonprofit research organization that tracks the start and end dates of U.S. recessions uses a broader set of economic indicators to define recessions, including employment rates, gross domestic income (GDI), wholesale-retail sales, and industrial production.
During a recession, these compounding impacts may manifest themselves in a variety of ways, including an increase in jobless claims, a shift in spending patterns, a slowing of sales, and a reduction in economic prospects.
What happens to the economy in a downturn?
- 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.
Why is a recession harmful to the economy?
During a recession, labor and capital unemployment causes a drop in economic output, as well as a drop in real per capita income. As a result of the decrease in real goods and services created, there is less to consume. As a result, many people are unable to maintain their quality of living. As a result of the stress, birth rates are declining and divorce rates are rising. Malnutrition and homelessness are on the rise among the poorest.
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)
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.
During a recession, what increases?
- A recession is defined as two consecutive quarters of negative economic growth, however there are investment strategies that can help safeguard and benefit during downturns.
- Investors prefer to liquidate riskier holdings and migrate into safer securities, such as government debt, during recessions.
- Because high-quality companies with long histories tend to weather recessions better, equity investment entails owning them.
- Fixed income products, consumer staples, and low-risk assets are all key diversifiers.
Why did money become scarce during the Great Depression?
During the Great Depression, the money stock decreased mostly due to banking panics. Depositors’ faith that they will be able to access their cash in banks whenever they need them is crucial to banking systems.
Is it wise to invest in real estate during a downturn?
Buying a home during a recession will, on average, earn you a better deal. As the number of foreclosures and owners forced to sell to stay afloat rises, more homes become available on the market, resulting in reduced housing prices.
Because this recession is unlike any other, every buyer will be in a unique position to deal with a significant financial crisis. If you work in the hospitality industry, for example, your present financial condition is very different from someone who was able to easily transition to working from home.
Only you can decide whether buying a home during a recession is feasible for your family, but there are a few things to think about.
Who is the most affected by a recession?
The groups who lost the most jobs during the Great Recession were the same ones that lost jobs throughout the 1980s recessions.
Hoynes, Miller, and Schaller use demographic survey and national time-series data to conclude that the Great Recession has harmed males more than women in terms of job losses. However, their research reveals that men have faced more cyclical labor market outcomes in earlier recessions and recoveries. This is partly due to the fact that men are more likely to work in industries that are very cyclical, such as construction and manufacturing. Women are more likely to work in industries that are less cyclical, such as services and government administration. While the pattern of labor market effects across subgroups in the 2007-9 recession appears to be comparable to that of the two early 1980s recessions, it did have a little bigger impact on women’s employment, while the effects on women were smaller in this recession than in previous recessions. The effects of the recent recession were felt most acutely by the youngest and oldest workers. Hoynes, Miller, and Schaller also discover that, in comparison to the 1980s recovery, the current recovery is affecting males more than women, owing to a decrease in the cyclicality of women’s employment during this period.
The researchers find that the general image of demographic patterns of responsiveness to the business cycle through time is one of stability. Which groups suffered the most job losses during the Great Recession? The same groups that suffered losses during the 1980s recessions, and who continue to have poor labor market outcomes even in good times. As a result, the authors conclude that the Great Recession’s labor market consequences were distinct in size and length from those of past business cycles, but not in type.
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 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 was the economic impact of the 2008 recession?
When the decade-long expansion in US housing market activity peaked in 2006, the Great Moderation came to an end, and residential development began to decline. Losses on mortgage-related financial assets began to burden global financial markets in 2007, and the US economy entered a recession in December 2007. Several prominent financial firms were in financial difficulties that year, and several financial markets were undergoing substantial upheaval. The Federal Reserve responded by providing liquidity and support through a variety of measures aimed at improving the functioning of financial markets and institutions and, as a result, limiting the damage to the US economy. 1 Nonetheless, the economic downturn deteriorated in the fall of 2008, eventually becoming severe and long enough to be dubbed “the Great Recession.” While the US economy reached bottom in the middle of 2009, the recovery in the years that followed was exceptionally slow in certain ways. In response to the severity of the downturn and the slow pace of recovery that followed, the Federal Reserve provided unprecedented monetary accommodation. Furthermore, the financial crisis prompted a slew of important banking and financial regulation reforms, as well as congressional legislation that had a substantial impact on the Federal Reserve.
Rise and Fall of the Housing Market
Following a long period of expansion in US house building, home prices, and housing loans, the recession and crisis struck. This boom began in the 1990s and accelerated in the mid-2000s, continuing unabated through the 2001 recession. Between 1998 and 2006, average home prices in the United States more than doubled, the largest increase in US history, with even bigger advances in other locations. During this time, home ownership increased from 64 percent in 1994 to 69 percent in 2005, while residential investment increased from around 4.5 percent of US GDP to nearly 6.5 percent. Employment in housing-related sectors contributed for almost 40% of net private sector job creation between 2001 and 2005.
The development of the housing market was accompanied by an increase in household mortgage borrowing in the United States. Household debt in the United States increased from 61 percent of GDP in 1998 to 97 percent in 2006. The rise in home mortgage debt appears to have been fueled by a number of causes. The Federal Open Market Committee (FOMC) maintained a low federal funds rate after the 2001 recession, and some observers believe that by keeping interest rates low for a “long period” and only gradually increasing them after 2004, the Federal Reserve contributed to the expansion of housing market activity (Taylor 2007). Other researchers, on the other hand, believe that such variables can only explain for a small part of the rise in housing activity (Bernanke 2010). Furthermore, historically low interest rates may have been influenced by significant savings accumulations in some developing market economies, which acted to keep interest rates low globally (Bernanke 2005). Others attribute the surge in borrowing to the expansion of the mortgage-backed securities market. Borrowers who were deemed a bad credit risk in the past, maybe due to a poor credit history or an unwillingness to make a big down payment, found it difficult to get mortgages. However, during the early and mid-2000s, lenders offered high-risk, or “subprime,” mortgages, which were bundled into securities. As a result, there was a significant increase in access to housing financing, which helped to drive the ensuing surge in demand that drove up home prices across the country.
Effects on the Financial Sector
The extent to which home prices might eventually fall became a significant question for the pricing of mortgage-related securities after they peaked in early 2007, according to the Federal Housing Finance Agency House Price Index, because large declines in home prices were viewed as likely to lead to an increase in mortgage defaults and higher losses to holders of such securities. Large, countrywide drops in home prices had been relatively rare in the US historical statistics, but the run-up in home prices also had been unparalleled in its extent and scope. Between the first quarter of 2007 and the second quarter of 2011, property values declined by more than a fifth on average across the country. As financial market participants faced significant uncertainty regarding the frequency of losses on mortgage-related assets, this drop in home values contributed to the financial crisis of 2007-08. Money market investors became concerned of subprime mortgage exposures in August 2007, putting pressure on certain financial markets, particularly the market for asset-backed commercial paper (Covitz, Liang, and Suarez 2009). The investment bank Bear Stearns was bought by JPMorgan Chase with the help of the Federal Reserve in the spring of 2008. Lehman Brothers declared bankruptcy in September, and the Federal Reserve aided AIG, a significant insurance and financial services firm, the next day. The Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation were all approached by Citigroup and Bank of America for assistance.
The Federal Reserve’s assistance to specific financial firms was hardly the only instance of central bank credit expansion in reaction to the crisis. The Federal Reserve also launched a slew of new lending programs to help a variety of financial institutions and markets. A credit facility for “primary dealers,” the broker-dealers that act as counterparties to the Fed’s open market operations, as well as lending programs for money market mutual funds and the commercial paper market, were among them. The Term Asset-Backed Securities Loan Facility (TALF), which was launched in collaboration with the US Department of Treasury, was aimed to relieve credit conditions for families and enterprises by offering credit to US holders of high-quality asset-backed securities.
To avoid an increase in bank reserves that would drive the federal funds rate below its objective as banks attempted to lend out their excess reserves, the Federal Reserve initially funded the expansion of Federal Reserve credit by selling Treasury securities. The Federal Reserve, on the other hand, got the right to pay banks interest on their excess reserves in October 2008. This encouraged banks to keep their reserves rather than lending them out, reducing the need for the Federal Reserve to offset its increased lending with asset reductions.2
Effects on the Broader Economy
The housing industry was at the forefront of not only the financial crisis, but also the broader economic downturn. Residential construction jobs peaked in 2006, as did residential investment. The total economy peaked in December 2007, the start of the recession, according to the National Bureau of Economic Research. The drop in general economic activity was slow at first, but it accelerated in the fall of 2008 when financial market stress reached a peak. The US GDP plummeted by 4.3 percent from peak to trough, making this the greatest recession since World War II. It was also the most time-consuming, spanning eighteen months. From less than 5% to 10%, the jobless rate has more than doubled.
The FOMC cut its federal funds rate objective from 4.5 percent at the end of 2007 to 2 percent at the start of September 2008 in response to worsening economic conditions. The FOMC hastened its interest rate decreases as the financial crisis and economic contraction worsened in the fall of 2008, bringing the rate to its effective floor a target range of 0 to 25 basis points by the end of the year. The Federal Reserve also launched the first of several large-scale asset purchase (LSAP) programs in November 2008, purchasing mortgage-backed assets and longer-term Treasury securities. These purchases were made with the goal of lowering long-term interest rates and improving financial conditions in general, hence boosting economic activity (Bernanke 2012).
Although the recession ended in June 2009, the economy remained poor. Economic growth was relatively mild in the first four years of the recovery, averaging around 2%, and unemployment, particularly long-term unemployment, remained at historically high levels. In the face of this sustained weakness, the Federal Reserve kept the federal funds rate goal at an unusually low level and looked for new measures to provide extra monetary accommodation. Additional LSAP programs, also known as quantitative easing, or QE, were among them. In its public pronouncements, the FOMC began conveying its goals for future policy settings more fully, including the situations in which very low interest rates were likely to be appropriate. For example, the committee stated in December 2012 that exceptionally low interest rates would likely remain appropriate at least as long as the unemployment rate remained above a threshold of 6.5 percent and inflation remained no more than a half percentage point above the committee’s longer-run goal of 2 percent. This “forward guidance” technique was meant to persuade the public that interest rates would remain low at least until specific economic conditions were met, exerting downward pressure on longer-term rates.
Effects on Financial Regulation
When the financial market turmoil subsided, the focus naturally shifted to financial sector reforms, including supervision and regulation, in order to avoid similar events in the future. To lessen the risk of financial difficulty, a number of solutions have been proposed or implemented. The amount of required capital for traditional banks has increased significantly, with larger increases for so-called “systemically important” institutions (Bank for International Settlements 2011a;2011b). For the first time, liquidity criteria will legally limit the amount of maturity transformation that banks can perform (Bank for International Settlements 2013). As conditions worsen, regular stress testing will help both banks and regulators understand risks and will force banks to use earnings to build capital rather than pay dividends (Board of Governors 2011).
New provisions for the treatment of large financial institutions were included in the Dodd-Frank Act of 2010. The Financial Stability Oversight Council, for example, has the authority to designate nontraditional credit intermediaries as “Systemically Important Financial Institutions” (SIFIs), putting them under Federal Reserve supervision. The act also established the Orderly Liquidation Authority (OLA), which authorizes the Federal Deposit Insurance Corporation to wind down specific institutions if their failure would pose a significant risk to the financial system. Another section of the legislation mandates that large financial institutions develop “living wills,” which are detailed plans outlining how the institution could be resolved under US bankruptcy law without endangering the financial system or requiring government assistance.
The financial crisis of 2008 and the accompanying recession, like the Great Depression of the 1930s and the Great Inflation of the 1970s, are important areas of research for economists and policymakers. While it may be years before the causes and ramifications of these events are fully known, the attempt to unravel them provides a valuable opportunity for the Federal Reserve and other agencies to acquire lessons that can be used to shape future policy.