Most recessions, on the other hand, are brought on by a complex combination of circumstances, such as high interest rates, poor consumer confidence, and stagnant or lower real wages in the job market. Bank runs and asset bubbles are two further instances of recession causes (see below for an explanation of these terms).
What causes a downturn in the economy?
A stock market crash is one of the effects of a recession. When consumers’ purchasing power is reduced, goods and services become difficult to market. As a result, company earnings decline in lockstep with their stock market price.
Another result of the recession is an increase in unemployment. Consumer spending is slowing, therefore businesses are cutting back on production. As a result of the reduction in production, people lose their jobs.
Another impact is the possibility of depression. A recession, in particular, might turn into a depression if it lasts for a long time.
Furthermore, during a recession, the government frequently spends money that it does not have to bail out firms. As the national debt rises, the government will be forced to spend less money on development.
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 happens when the economy is 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 did the Great Recession happen?
The Great Recession, which ran from December 2007 to June 2009, was one of the worst economic downturns in US history. The economic crisis was precipitated by the collapse of the housing market, which was fueled by low interest rates, cheap lending, poor regulation, and hazardous subprime mortgages.
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.
Do wars induce economic downturns?
The majority of wars in history have occurred in response to economic crises; there have been very few instances in which the world has experienced a slowdown or recession as a result of hostilities. After the First World War, the economy went into a three-year slump from 1918 to 1921.
How can we avoid a downturn?
A recession is defined as a drop in real GDP or a period of negative economic growth. To avoid a recession, the government and the central bank must endeavor to boost aggregate demand (consumer spending, investment, exports). They can’t promise that they’ll function. It will be determined by the policies implemented as well as the reasons of the recession.
- Monetary policy loosening interest rates are decreased to lower borrowing costs and boost investment.
- Expansionary fiscal policy – higher government expenditure supported by borrowing will allow investment into the circular flow to be injected.
- Ensure financial stability – in the event of a credit crunch, government involvement to guarantee bank deposits and key financial institutions can help the banking sector maintain credibility.
If very high interest rates are causing the recession, then lowering interest rates may help avoid one. However, if asset prices fall sharply and banks lose money (a situation known as a balance sheet recession), it becomes more difficult since banks may refuse to lend even if interest rates are decreased.
Policies to avoid a Recession
1. Monetary policy that is expansionary interest rates are being lowered. Interest rates being cut should assist improve aggregate demand. Lower interest rates, for example, cut mortgage interest payments, leaving customers with more disposable cash. Interest rates that are lower encourage businesses and people to spend rather than save. (as a result of the decreased interest rates)
The monetary authorities could strive to lower other interest rates throughout the economy in addition to decreasing base rates. The Central Bank, for example, could purchase government bonds or mortgage securities. Purchasing these bonds lowers interest rates and stimulates economic spending.
Lower interest rates, on the other hand, do not always work. Interest rates in the UK were slashed to 0.5 percent in 2008-09, but the country still experienced a recession. This was due to the following:
- Despite low loan rates, banks were hesitant to lend and consumers were hesitant to spend.
2. Easing quantitatively If interest rates are already at zero, the Central Bank may be forced to adopt unconventional monetary policies. Quantitative easing entails the central bank producing money electronically and using it to purchase long-term securities. This boosts bank reserves, which should help banks lend more. It also lowers bond interest rates, which should boost consumption and investment. See also: What Is Quantitative Easing?
3. Money in the form of a helicopter. Helicopter money is a policy that aims to expand the money supply by giving money to consumers directly. This works well in a deflationary environment, where people are hesitant to spend and banks are hesitant to lend money. See also: Helicopter cash
4. Fiscal policy that is expansionary
Increased government expenditure and/or tax cuts are examples of expansionary fiscal policy. Government borrowing is used to fund this infusion into the circular flow. When the government lowers income taxes or the VAT, it boosts disposable income and thus spending.
If fiscal and monetary policy are both effective, AD will rise, resulting in an increase in real GDP.
- If confidence is low, there is no certainty that tax cuts will raise expenditure. Some economists worry that increased government borrowing will lead to crowding out, in which the private sector lends to the government but subsequently spends less. In a recession, however, there will be surplus savings, so there will be no crowding out, and fiscal policy will be helpful in boosting demand and preventing a recession, according to Keynes. Is it possible to avoid a recession by lowering taxes?
- Expansionary fiscal policy is less feasible for Eurozone countries, which have less flexibility over borrowing levels.
5. Maintain financial security. During the 2008 credit crisis, there was a risk that savers might lose faith in bank savings. Customers were forming lines to withdraw their funds. If individuals lose faith in the financial system, it could result in bank closures, a quick drop in trust, and a reduction in the money supply (like the US in 1932). As a result, the Central Bank/government serves as a lender of last resort, ensuring savings. Bank losses and a drop in consumer spending might result from home repossessions.
The government may try to avoid home repossession by freezing mortgage rates or providing subsidies to households facing foreclosure.
6. Depreciation. A rise in aggregate demand can be triggered by a depreciation in the currency rate. Exports become cheaper and imports become more expensive as the value of the dollar falls, increasing domestic demand. (See: Devaluation Effects)
When the UK abolished the Gold Standard in 1932, the Pound fell, allowing the UK economy to recover faster than other countries during the Great Depression.
In a worldwide recession, however, export demand may be highly inelastic. In a global recession, countries may also seek to devalue their currencies in order to remain competitive. This occurs when a group of countries seeks to obtain a competitive edge by depreciating their currencies against those of other countries, but it is self-defeating.
7. Aim for a higher inflation rate. This is a deliberate choice to focus on growth rather than inflation. The premise is that if the economy is locked in a low-inflation phase, it will result in slower economic growth. Breaking out of a deflationary spiral requires aiming for a higher inflation rate. See also: Inflation target that is optimal.
8. A bailout of major corporations by the government. The Obama government agreed to bail out the US automobile sector in 2009, when it was facing financial difficulties. The argument was that closing the automotive sector would worsen the recession, increase unemployment, and have a large negative multiplier effect. The bailout saved employment and kept the economy from collapsing.
In actuality, it is extremely impossible for a government or central bank to avoid recessions all of the time. If the global economic outlook is bleak, monetary and fiscal policy may not be sufficient. In addition, there are considerable temporal gaps in the policies. However, the appropriate mix of fiscal and monetary policy can at the very least limit the slump and hasten the recovery. Other policies, such as, may be suitable depending on the economic situation.
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.
Is the economy on the decline?
The economic expansion that began in mid-2009 and ended in early 2020 came to an abrupt halt. In March 2020, the commencement of COVID-19 caused a severe decrease in economic activity, resulting in a 5.1 percent annual decline in real GDP in the first quarter and 31.2 percent in the second quarter.
What triggered the Great Recession of 2008?
The Federal Reserve hiked the fed funds rate in 2004 at the same time that the interest rates on these new mortgages were adjusted. As supply outpaced demand, housing prices began to decrease in 2007. Homeowners who couldn’t afford the payments but couldn’t sell their home were imprisoned. When derivatives’ values plummeted, banks stopped lending to one another. As a result, the financial crisis erupted, resulting in the Great Recession.