During a recession, actual economic output falls short of its potential, resulting in a negative output gap.
What happens to the economy during a downturn?
A recession is characterized as a prolonged period of low or negative real GDP (output) growth, which is accompanied by a considerable increase in the unemployment rate. During a recession, many other economic indicators are equally weak.
What happens to manufacturing during a downturn?
In economics, a recession is a negative tendency in the business cycle marked by a drop in production and employment, which leads household incomes and spending to drop. Even if not all people and businesses face actual income drops, their future expectations become less assured during a recession, causing them to postpone significant purchases or investments.
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.
What happens when the economy falls apart?
Although economies can and do undergo economic collapse, there is a significant motivation for national governments to use fiscal and monetary policy to try to prevent or mitigate the severity of such a collapse. Several waves of interventions and fiscal measures are frequently used to combat economic collapse. Banks may close to limit withdrawals, new capital controls may be implemented, billions of dollars may be injected into the economy via the financial system, and entire currencies may be revalued or replaced. Despite government attempts, some economic breakdowns result in the overthrow of both the administration responsible for the collapse and the government responding to it.
What happens when actual output exceeds prospective output over time?
When actual output falls short of projected output, a negative output gap occurs. On Figure 2, you may detect negative output gaps: Look for places where the red (real GDP) line crosses the blue line (real potential GDP). A negative production gap and underutilization of resources characterize an economy that is operating below its capacity. That example, many offices and factories may be closed or operating at less than full capacity, and the unemployment rate is expected to rise, showing that the economy is not at full potential. In terms of the business cycle, this usually indicates that the economy is in a downturn. Figure 2 shows how negative production gaps correspond to recessions (shaded areas) (the red line drops below the blue line).
When the economy is “overachieving,” a positive output gap arises, in which actual output exceeds potential output. While this may be feasible in the short term, it is uncommon and, in the long run, unsustainable. Consider the week or so leading up to your final examinations. You might forego social activities and study late into the night, only to get up early the next day to study some more. You might be able to stick to such a schedule for a while, but most individuals would find it unsustainable over time. For the economy, this might happen as a result of workers working extra shifts or production lines and machinery running without the necessary downtime and maintenance. In terms of the business cycle, this usually indicates that the economy is growing. When this happens, unemployment is expected to be low and declining.
In simple terms, a positive output gap arises when actual output exceeds potential output, indicating that the economy is fully employed and resources are being overutilized. The red line (real GDP) is above the blue line in Figure 2, indicating positive output gaps (real potential GDP). Although the economy can grow faster than its long-term potential, this pace is unsustainable over time.
NOTE: As the economy grows, the output gap narrows and, in most situations, narrows to a positive value. The output gap widens and becomes negative as the economy contracts. The synchronization between the output gap becoming negative and the start of recessions is seen graphically, but it is erratic.
Actual output differences from potential productionthat is, real GDP differences from real potential GDPmight appear minor (Figure 3). However, when stated as a percentage of real potential GDP, the disparities become more visible (Figure 4 ). Swings into negative territory can have a significant detrimental impact on people’s lives. For example, the negative output gap associated with the Great Recession of 2007-09 increased unemployment from 4.4 percent shortly before the recession began to 10% in late 2009, and the COVID-19 pandemic-related recession that began in spring 2020 increased unemployment from 3.5 percent to 14.8 percent. Unemployed people face difficulties such as living off savings, going into debt to cover costs, and perhaps losing their houses and cars. They could also have trouble obtaining work after a long period of unemployment.
Has the United States ever experienced hyperinflation?
The trend of inflation in the rest of the world has been quite diverse, as seen in Figure 2, which illustrates inflation rates over the last several decades. Inflation rates were relatively high in many industrialized countries, not only the United States, in the 1970s. In 1975, for example, Japan’s inflation rate was over 8%, while the United Kingdom’s inflation rate was around 25%. Inflation rates in the United States and Europe fell in the 1980s and have mainly been stable since then.
In the 1970s, countries with tightly controlled economies, such as the Soviet Union and China, had historically low measured inflation rates because price increases were prohibited by law, except in circumstances where the government regarded a price increase to be due to quality improvements. These countries, on the other hand, were plagued by constant shortages of products, as prohibiting price increases works as a price limit, resulting in a situation in which demand much outnumbers supply. Although the statistics for these economies should be viewed as slightly shakier, Russia and China suffered outbursts of inflation as they transitioned toward more market-oriented economies. For much of the 1980s and early 1990s, China’s inflation rate was around 10% per year, however it has since declined. In the early 1990s, Russia suffered hyperinflationa period of extremely high inflationover 2,500 percent a year, yet by 2006, Russia’s consumer price inflation had dropped to 10% per year, as seen in Figure 3. The only time the United States came close to hyperinflation was in the Confederate states during the Civil War, from 1860 to 1865.
During the 1980s and early 1990s, many Latin American countries experienced rampant hyperinflation, with annual inflation rates typically exceeding 100%. In 1990, for example, inflation in both Brazil and Argentina surpassed 2000 percent. In the 1990s, several African countries had exceptionally high inflation rates, sometimes bordering on hyperinflation. In 1995, Nigeria, Africa’s most populous country, experienced a 75 percent inflation rate.
In most countries, the problem of inflation appeared to have subsided in the early 2000s, at least when compared to the worst periods of prior decades. As we mentioned in an earlier Bring it Home feature, the world’s worst example of hyperinflation in recent years was in Zimbabwe, where the government was issuing bills with a face value of $100 trillion (in Zimbabwean dollars) at one pointthat is, the bills had $100,000,000,000,000 written on the front but were nearly worthless. In many nations, double-digit, triple-digit, and even quadruple-digit inflation are still fresh in people’s minds.
How does inflation cause joblessness?
The Phillips curve depicts the relationship between unemployment and inflation. In the short run, unemployment and inflation are inversely connected; as one measure rises, the other falls. There is no trade-off in the long run. The short-run Phillips curve was thought to be stable in the 1960s by economists. Economic events in the 1970s put an end to the idea of a predictable Phillips curve. What could have happened in the 1970s to completely demolish a theory? A supply shock has resulted in stagflation.
Stagflation and Aggregate Supply Shocks
Stagflation is a combination of the terms “stagnant” and “inflation,” which describes the characteristics of a stagflation-affected economy: low economic growth, high unemployment, and high inflation. A succession of aggregate supply shocks contributed to the 1970s stagflation. The Organization of Petroleum Exporting Countries (OPEC) raised oil prices dramatically in this example, causing a significant negative supply shock. Increased oil prices translated into much higher resource prices for other items, reducing aggregate supply and shifting the curve to the left. As aggregate supply fell, real GDP output fell, causing unemployment to rise and price levels to rise; in other words, the shift in aggregate supply resulted in cost-push inflation.
What happens when there is hyperinflation?
- Hyperinflation is defined as an economy’s rapid and unrestricted price increases, which often reach 50% per month over time.
- Hyperinflation can occur in the underlying production economy during times of war and economic turbulence, when a central bank prints an excessive amount of money.
- When basic supplies, such as food and gasoline, become limited, hyperinflation can create a price spike.
- Hyperinflations are uncommon, but once they start, they can quickly spiral out of control.
During a recession, what happens to imports and exports?
Readers’ Question: But, in a recession, what happens to the balance of payments? (Excerpted from What Happens During a Recession)
During a recession, the current account is more likely to improve (reduction in deficit). Because of the following reasons:
- In a recession, consumer spending reduces, and as a result, import expenditure lowers.
- Interest rates are lowered during a recession. As a result, the currency rate depreciates, making exports less expensive and imports more costly. The current account benefits from the lower exchange rate.
Current account deficits are frequently cyclical, rising when consumer demand is high and falling when consumer demand is low. This is especially true for a country with a large marginal tendency to import, such as the United Kingdom.
Furthermore, before an exchange rate depreciation has an influence on the current account deficit, there is often a time lag.
It is also affected by the global economic cycle. If a country suffers a recession at the same time as all of its major trading partners, the impact on export-import expenditure will be less evident. Because, even if the country cuts its import spending, it will also reduce its export demand.
A recession, on the other hand, is not certain to improve the current account deficit, especially for nations that rely on export-led growth like Germany and China. In a global recession, they may face a drop in demand for their exports, resulting in a current account deficit. However, economies such as the United States and the United Kingdom are more reliant on consumer spending, thus a drop in economic growth leads to a greater drop in import spending.
US current account 1960 2017
Recessions hit the United States in 1980, 1991, and 2008/09. We can notice an improvement in the US current account a reduction in the deficit during these times.
UK current account
During the recessions of 1981 and 1991, the UK’s current account improved. Despite dismal economic development, there was a minor rebound in 2009, but it deteriorated from 2010 to 2015.