Ever heard the term “recession?” Chances are, your definition is quite different from what economists actually mean when they use the word. In this article, we’ll take a closer look at what a recession is and explore some of the reasons why this economic decline happens.
What Does Recession Mean?
A recession is a decline in economic activity spread across the economy, lasting more than a few months. Recessions are characterized by a drop in gross domestic product, higher unemployment, and falling prices in financial markets. In the United States, a recession is typically defined as two consecutive quarters of negative economic growth.
What Causes a Recession?
There’s no single cause of a recession. Instead, recessions are typically caused by a combination of factors. Let’s take a look at the six main things that cause a recession:
Decrease in Consumer Spending and Economic Growth
Consumer spending is a key driver of a growing economy. When people stop spending money, businesses make less money and are forced to cut back on their own spending.
This can lead to layoffs and a decrease in production, which further reduces consumer spending and creates a feedback loop that can cause a recession.
Cut Backs in Business Investment
Business investments play a crucial role in stimulating economic activity and growth. When companies start retracting their investment initiatives, several repercussions can emerge:
- Delayed Expansion: Businesses might postpone or abandon plans for expansion, such as opening new branches or introducing new product lines. This not only affects the immediate prospects of the company but can also ripple through the economy by affecting related sectors and job markets.
- Reduced Capital Expenditures: A decrease in expenditures on essential machinery, technology, or infrastructure can impact the industries that supply these goods and services, amplifying the economic downturn and leading to potential supply chain disruptions.
- Impact on Employment: With reduced investment projects, there’s often a direct impact on job creation. This can result in layoffs or a hiring freeze, which, in turn, affects consumer spending and confidence, further straining the economy.
- READ MORE: 19 Recession-Proof Businesses
Government Cuts Back on Spending
Government spending can also contribute to a recession. When the government cuts back on its spending, it can lead to a decrease in jobs, and production.
Decrease in Exports
One of the pivotal contributors to a country’s economic well-being is its ability to sell goods and services to other countries. When there’s a significant decline in exports:
- Trade Balance Impact: The trade balance, which is the difference between a country’s exports and imports, can go into a deficit if the exports decrease sharply. Persistent trade deficits can drain a country’s foreign reserves and lead to unfavorable trade terms.
- Decreased Production: Reduced demand from international markets can cause factories and producers to cut back on their production. This can lead to a domino effect where related industries, such as logistics and suppliers, also face reduced demand.
- Job Losses: As production declines, there’s often a subsequent reduction in the workforce. Industries that heavily rely on exports might lay off employees or halt hiring, leading to increased unemployment rates.
- Reduced Income for Government: Export duties and taxes are a significant source of revenue for many governments. A slump in exports means lesser income for the government, which can affect public spending and investments.
- Negative Impact on Currency Value: Consistent decrease in exports can lead to a devaluation of the national currency. A weaker currency can make imports more expensive, which can increase the cost of living and reduce purchasing power.
- Reduced Business Confidence: Prolonged periods of decreased exports can erode business confidence. Investors and businesses might become reluctant to invest in sectors that are export-heavy, fearing continued lack of demand from international markets.
Increase in Imports
An increase in imports can also cause a recession. When we buy more goods and services from other countries, it can lead to a decrease in production and jobs here at home.
Interest Rates Increasing
An increase in interest rates can also cause a recession. When the Federal Reserve Bank raises interest rates, it becomes more expensive to borrow money.
This can lead to a decrease in investment and consumer spending, which can lead to a decrease in production and jobs.
|Delayed Expansion||Postponed or cancelled growth plans, affecting company prospects and related sectors.|
|Reduced Capital Expenditures||Decrease in spending on machinery, tech, or infrastructure, impacting related industries and causing supply chain disruptions.|
|Impact on Employment||Layoffs or hiring freezes due to reduced projects, decreasing consumer spending and overall economic confidence.|
Economic Indicators of a Recession
There are several key economic indicators that can help to show whether or not an economy is experiencing a recession. When an economic analysis is performed, these indicators are often taken into account in order to give a more accurate picture of the current state of the economy. Let’s take a look at four indicators of a recession:
A Significant Decline in Economic Activity
One of the most obvious indicators of a recession is a significant decline in activity in the economy for consecutive quarters.
This can be measured in various ways, but one of the most common is to look at the gross domestic product (GDP).
GDP is the total value of all goods and services produced within a country’s borders in a given period of time, and it is often used as a measure of a country’s economic health.
Rising Unemployment Rate
Another key indicator of a recession is the rise of the unemployment rate. When people lose their jobs, they have less money to spend, which can lead to a decrease in consumer spending and a further decline in activity in the economy.
Plummeting Stock Market
A plummeting stock market is another key indicator of a recession. When the stock market crashes, it can signal that investors are losing confidence in the economy and are selling off their assets. This can lead to a decline in economic activity as well.
Decrease in Housing Prices
Finally, a decrease in housing prices is another key indicator of a recession. When housing prices go down, it can signal that the economy is weak and that people are not interested in buying homes.
This can lead to more foreclosures and a decrease in the value of homes, which can further hurt the economy.
Recessions and Business in Economic Research
In business, as in life, we are subject to the ebb and flow of cycles. Recessions are a part of these business cycles. They’re periods of slowdown or contraction during which businesses experience decreased demand for their products or services. As a result, they may cut back on production, lay off workers, or otherwise scale back their operations.
How Long Do Recessions Last?
This is a question that’s been asked since the world economy collapsed in the wake of World War II. In the years immediately following the war, the world was in the grips of a global recession.
It lasted for more than a decade and saw unemployment levels reach unprecedented heights. T
hen there was the gulf war recession, which began in 1990 as a result of the Gulf War, and it lasted just over two consecutive quarters.
How Do Recessions Work?
A recession is when people stop buying stuff and it’s a part of the business cycle. That’s all. The act of not buying stuff is called “deleveraging.” Deleveraging is when people and businesses reduce their debt levels by paying off their loans and credit lines.
This is done by either selling assets or by increasing savings. Once people start deleveraging, the economy slows down because there is less money being spent.
This leads to layoffs and more businesses going bankrupt. The further the economy falls, the more deleveraging occurs, and the deeper the recession becomes.
Recession Vs Depression
An economic recession is a period of temporary decline in the economy during which trade and industrial activity are reduced.
A depression is a more prolonged and severe period of the economy being in a decline that typically involves a sharp decrease in output, employment, and prices (deflation).
They’re similar in that both periods of decline in the economy are characterized by falling output and employment. However, depressions are usually much more severe, with sharper decreases in output and employment.
Planning Ahead and Taking The Positives
Recessions have come and gone since the beginning of our country’s existence, and they’ll continue to do so.
Economic research shows they’re a natural part of the business cycle and while they can be painful, they’re also a necessary part of the economy’s growth. Believe it or not, there are some benefits to a recession such as:
- Recessions can be a time of great opportunity – Many people are able to buy homes and invest in businesses at bargain prices.
- They can force businesses to become leaner and more efficient – This can lead to increased productivity and profitability in the long run.
- Recessions can lead to innovation – Necessity is the mother of invention, and businesses may be forced to develop new products and services to survive during a recession.