When the gross domestic product (GDP) or other macroeconomic indices, such as unemployment, show negative growth for two or more quarters in a row, the economy is said to be in recession. In part, the link between unemployment and recession is largely semantic; official recession dates include a rise in unemployment as part of the definition of what constitutes a recession.
What are the primary causes of the current economic downturn?
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 are the warning signals of impending recession?
Real gross domestic product (GDP), or goods produced minus inflationary impacts, is the economic measure that most clearly identifies a recession. This might look like this:
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.
How can we avoid economic downturns?
I’m not sure when it’ll happen or if the yield curve indicates a downturn is on the way, but unemployment will start to rise, and growth will stall and finally turn negative unless the Fed and Congress are far more capable than I believe they are.
When the financial crisis of 2008 hit, the US government deployed two instruments to combat it: monetary policy administered by the Federal Reserve and fiscal policy determined by Congress.
Both contributed tremendously, yet both fell short of what the country required. Millions of people were unemployed when they didn’t have to, jeopardizing their long-term economic prospects and increasing mortality rates, not least owing to suicide.
In September 2008, just as Lehman Brothers was crumbling, Fed Chair Ben Bernanke made the perplexing decision not to decrease interest rates to boost recovery. The American Recovery and Reinvestment Act of 2009, also known as the fiscal stimulus, looks to have succeeded, although it was insufficient.
There are a number of policies that the Fed and Congress may implement right now to make a future recession less severe, if not altogether avoidable. Since the crash, economists and policy analysts have proposed a slew of ideas.
The proposals are all based on the same premise: the system failed the last time. There’s no reason why unemployment in the United States should ever approach 10%, and why a recession and recovery should take as long as they did. Better fiscal, monetary, and legal policies would have put more stimulus into the economy and gotten us back to low unemployment and consistent growth sooner.
To avoid politicians making the same mistakes again, many of these measures include automatic procedures that allow stimulus to begin as soon as economic turmoil arises, rather than waiting for Congress to act.
This is by no means a comprehensive list, but these are some of the most spectacular and potential recession-proofing ideas now available.
Pay out more food stamps when unemployment is high
The basic rationale for fiscal stimulus during recessions such as the Pelosi-Bush stimulus package of 2008 or the 2009 stimulus that became synonymous with Obama’s recovery policy is that increased government spending can boost growth, both because it represents growth and because it can spur private-sector spending. The fiscal multiplier, which quantifies the increase in economic activity for every $1 of government expenditure or tax cuts, measures this effect.
The multiplier varies greatly across different types of expenditure or tax cuts, with the Supplemental Nutrition Assistance Program likely being the most beneficial (SNAP, or food stamps). SNAP expenditure increased growth by $1.74 in 2009, at the depths of the recession, and by $1.22 in 2015, far into the recovery, according to Mark Zandi of Moody’s Analytics.
Not only did $1 in new government expenditure boost growth in 2009, but it also prompted 74 cents in private sector spending. (It should be noted that these are only estimations.) During the Obama administration, I overheard top economist Jason Furman joke that everyone referenced the Zandi numbers because he was the only one who had two decimal places in his forecasts.)
SNAP is already an automatic stabilizer: because eligibility is based on income, the number of persons receiving benefits, as well as the size of the average benefit, increases during recessions, immediately helping to combat recessions. Congress, on the other hand, could do more. In a research by the Center on Budget and Policy Priorities, Jared Bernstein and Ben Spielberg recommended that as state unemployment rates rise, Congress might pay larger SNAP benefits.
Alan Blinder of Princeton has reiterated the concept of temporarily raising SNAP benefits, as well as suggesting that unemployment insurance payments be automatically increased during recessions (which Zandi’s analysis finds is nearly as stimulative as food stamps).
Automatically cut payroll tax rates
Blinder also proposes that when unemployment rises, payroll tax rates be automatically reduced. This is a pretty common suggestion; for example, Obama’s budget chief, Peter Orszag, presented it in 2011. This could be accomplished in a variety of ways. You might create a separate Making Work Pay tax credit to refund payroll taxes paycheck to paycheck, like Congress did in 2009, or you could just lower the payroll tax rate directly, as Congress did in 2010.
According to Zandi’s calculations, payroll tax cuts have a multiplier of 1.27, which isn’t as good as unemployment assistance or food stamps, but not awful. And the payroll tax rate is a straightforward, straightforward lever that should be easy to link to unemployment. If the situation becomes extremely desperate, you could even imagine the payroll tax rate being negative and adding to paychecks.
Government-created jobs when unemployment rises
The TANF emergency fund, which granted money to states to offer subsidized jobs to low-income persons under the Temporary Assistance to Needy Families program, was arguably one of the most effective aspects of the 2009 stimulus.
Although the fund was not carefully assessed, retroactive evaluations revealed that it was effective at producing jobs at a cheap cost: $1.3 billion in federal investment resulted in almost 260,000 new jobs, a ratio of about $5,000 per job generated. The fact that the sponsored work initiatives were set up and implemented promptly was particularly encouraging, implying that large-scale direct job creation in the modern period is administratively feasible.
Sen. Ron Wyden (D-OR) and Rep. Danny Davis (D-IL) have introduced the ELEVATE Act, which would create a comparable subsidized work program and connect federal funding to state unemployment rates. States would have a lot of leeway in terms of how those subsidized jobs are structured, but they’d have to stick to models that have a lot of evidence behind them.
Force down electric, water, heat, and cable bills
Yale economist and law professor Yair Listokin proposes that utility companies purposely hold down prices for gas, electricity, and other fundamental expenditures during recessions in his new book Law and Macroeconomics: Legal Remedies to Recessions.
Normally, he observes, utilities work in the opposite direction. During recessions, people spend less, thus utilities typically want the flexibility to raise rates to compensate for the lost revenue. This pulls money out of families’ pockets at a time when the economy needs them to spend more. It’s especially difficult for low-income families, whose power bills account for a large portion of their monthly expenses.
Having regulators deny utilities the ability to raise rates or force them to drop rates, on the other hand, acts as a tax reduction that directly enhances impoverished households’ spending power. This isn’t only something Congress or the Fed could do; it’s something city governments could do as well.
Promise to forgive mortgages
Greater pro-consumer mortgage/foreclosure legislation, according to economists Amir Sufi and Atif Mian, might lead to more debt forgiveness, more spending, and a faster recovery. He contends that, in order to avoid stifling demand, judges deciding on construction projects should default to building rather than not building during recessions.
This is also an area where Congress has the power to intervene. The Obama administration’s major mortgage relief program mostly benefited mortgage servicers; in fact, it refused to assist mortgage holders by failing to implement cramdown legislation that would allow bankruptcy judges to reduce mortgage payments. Passing cramdown would be a fantastic method to allow judges to reduce debt and make the next recovery easier.
Change what the Fed is targeting
The Federal Reserve currently claims to be targeting inflation: it wants overall prices to rise by 2% year over year. That means that if the economy tanks and prices stop rising or even begin to decline, the government has pledged to taking measures, such as decreasing interest rates, to help prices grow even faster.
If, on the other hand, prices begin to rise too quickly (maybe because the economy has recovered, employees are demanding higher pay, and those higher earnings drive firms to raise their prices, etc. ), the Fed will raise interest rates to keep inflation under control.
There have been several issues with this strategy. For one thing, during the recovery from the Great Recession, the Fed was unable to achieve 2% inflation and consistently undershot that target. That failure could have resulted from the Fed’s inability to employ its customary instrument for inducing inflation (reducing interest rates): It had kept interest rates around zero since 2008, so it was confined to quantitative easing (purchasing huge amounts of long-term bonds to lower long-term interest rates) and declaring if it wanted to do more to boost inflation.
During the recession, several economists, notably Bentley professor and influential blogger Scott Sumner, former Obama senior economist Christina Romer, and monetary policy expert Michael Woodford, urged for the Fed to embrace NGDP targeting.
Rather than aiming for a certain level of inflation, the Fed would endeavor to ensure that nominal gross domestic product (NGDP) the total amount of money spent in the economy rises by the same amount each year. If it falls behind, a recession is likely, and the Fed will need to intervene to boost growth. If it goes too far, it’s a sign that inflation is out of control and the Fed needs to tighten up.
In comparison to an inflation objective, an NGDP target would signal to markets that the Fed is committed to boosting growth and combating unemployment during recessions, not merely fighting out-of-control inflation. According to proponents, just sending that notification would lessen the severity of recessions.
“The Fed could increase confidence and expectations of future growth by promising to do whatever it takes to return nominal GDP to its pre-crisis trajectory,” Romer wrote in 2011. “Consumers who are more certain that they will have a job next year will be less hesitant to spend, and corporations who feel sales will rise will be more eager to invest.”
Right now, the Fed may decide to adopt an NGDP goal on its own. However, Congress may compel it to do so, just as it did when it was obliged to emphasize full employment and price stability. The Bank of England is expected to enforce the inflation target set by Parliament in the United Kingdom. That would be against American central bank independence principles, but it’s a perfectly valid model we could borrow, and it would be fully within Congress’s authority to approve a bill setting an NGDP target of, say, 5% year-over-year growth.
Try for higher inflation
Perhaps NGDP targeting is a step too far for the Fed; it differs too much from the inflation targeting it has practiced for years. Perhaps an easier solution would be to just increase the inflation objective from 2% to 4%.
The Federal Reserve can’t lower its interest rate too low. People would begin withdrawing their money from banks and hoarding it in cash form if interest rates reached, say, -10 percent. In monetary policy, this is referred to as the “zero lower bound.” However, the bound is nominal rather than inflation-adjusted. A Fed interest rate of zero is effectively a -2 percent rate in real, inflation-adjusted terms when inflation is 2%.
As a result, Laurence Ball, a Johns Hopkins academic, has recommended changing to a 4% inflation objective, which would allow for a negative 4% real rate at the bottom. During downturns, this provides the Fed a lot more leeway to act.
Have the Fed distribute cash directly to people
If everything goes as planned, an NGDP target or higher inflation aim would be self-enforcing: the Fed would publish their intentions, and markets would adapt accordingly. That is what optimists like Sumner believe will occur.
But let’s imagine the markets don’t adjust on their own and demand that the Fed take more concrete steps to reach its goals. Let’s imagine interest rates are already at or near zero percent when the Fed starts to worry about undershooting its NGDP or inflation target.
It’s capable of a number of things. It might acquire Treasury bonds and mortgage-backed securities, as it did during previous rounds of quantitative easing. It might abandon the QE strategy of buying a predetermined quantity of assets and instead declare that it will buy as much as it can until it meets its goals. It may, like the Bank of Japan, take economist Roger Farmer’s suggestion and buy conventional equities.
However, it might make sense for Congress to provide it with a new tool: helicopter drops. Congress may give the Fed the authority to print money and deliver it directly to Americans, for example, through a universal basic income-style cash transfer to all adults or households, or by lowering payroll tax rates and covering the difference in printed money.
This would have a more visible distributional impact than quantitative easing since it would direct more resources to poor households, and it might be more successful because poor households are more likely to spend extra money rather than store it.
Abolish cash money
The zero lower limit hypothesis assumes that central banks are unable to set negative interest rates. But, properly speaking, this isn’t the case. Since 2014, the European Central Bank and the Danish National Bank, for example, have had somewhat negative rates. If you keep money with them, you must pay them a fraction of a percent interest.
However, there’s a reason why both the ECB and Denmark have kept their rates at a low level of negative 0.4 percent (the current ECB rate). If they went substantially negative, the expenses of keeping currency in the banking system versus pulling it out and storing it in a large locker Breaking Bad-style would become overwhelming, and people would simply withdraw all of their cash.
What does a recession look like?
There have been five such periods of negative economic growth since 1980, all of which were classified as recessions. The worldwide recession that followed the 2008 financial crisis and the Great Depression of the 1930s are two well-known examples of recession and depression. A depression is a severe and long-term economic downturn.
What are the two most important indicators that the economy is expanding?
Indicators of a Growing Economy There are several crucial factors that might help anticipate whether or not an expansion will take place soon. They’re raising business profits, capital expenditures for operations maintenance and expansion, and interest rates.
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 happens if the economic downturn lasts too long?
An economic downturn can be catastrophic for both businesses and individuals, because the two are inextricably linked.
Assume a company that makes widgets is experiencing a drop in sales and earnings. It will most likely decide to produce fewer widgets, which means fewer staff will be needed to run the assembly line and sell the widgets to retailers. From there, the consequences spread to a slew of ancillary enterprises near the core widget-maker. Because they are producing fewer widgets, they require less machinery, which has an impact on machine producers and repairers. Because retailers have fewer widgets on their shelves, sales are down. And the widget manufacturer may decide that it does not want to launch a second line of widgets after all, so it ceases to engage in research, design, and marketing.
All of the linked employees’ livelihoods are thus impacted, which might cause them to lose faith in the company. They, in turn, buy less widgets from other companies, putting all widget makers in the same boat. People are also less likely to eat out, travel, or renovate their homes, among other things. They may even cease paying their payments, producing even more problems for goods and service providers. It’s easy to understand how the loop is self-reinforcing. A recession begins as everyone pulls back.
Because corporations are producing and selling fewer widgets, the stock market is likely to collapse as the spending slump deepens. Consumers’ jobs may be lost, or their hours or income may be cut. They may have difficulty paying their bills at that moment, leading to credit problems and, in extreme circumstances, bankruptcy.
As a result of the coronavirus outbreak, we’re already witnessing some of these symptoms. Businesses are closing (some temporarily), and millions of people are losing their full-time jobs or contract work. As a result, they have less money to spend and may struggle to pay their expenses. With a $2 trillion stimulus plan that would deliver cash payouts to Americans, create a fund to lend to small firms, and enhance (and expand eligibility for) unemployment benefits, the government has stepped in to try to alleviate the consequences.
During a recession, what does the government do?
- The use of government spending and tax policies to impact economic circumstances is referred to as fiscal policy.
- Fiscal policy is largely founded on the views of John Maynard Keynes, who claimed that governments could regulate economic activity and stabilize the business cycle.
- During a recession, the government may use expansionary fiscal policy to boost aggregate demand and boost economic growth by decreasing tax rates.
- A government may follow a contractionary fiscal strategy in the face of rising inflation and other expansionary signs.