What is a Recession?
In economics, a recession is a contraction in the business cycle. It is characterized as a decline in economic activity, which can be measured by various macroeconomic indicators.
In recessions the following factors drop: GDP (gross domestic product), investment spending, household income, inflation, and business profits. While the following factors typically increase: bankruptcies and the unemployment rate.
Recessions can be caused by an adverse demand shock, an external trade shock, an economic bubble burst, or a financial crisis. Economists say that if nothing is done to address banks’ reluctance to lend money (credit crunch), recessions get worse or last longer.
Advocates of Keynesian economics say that without government intervention to boost economic activity, nations can stay stuck in a recession for prolonged periods.
When a government detects signs of a slowdown, they usually start off by increasing the money supply, decreasing taxation, and increasing government spending.
There are various definitions of what a recession is – some economists believe that it occurs when there has been a 1.5% rise in unemployment in the past year.
National Bureau of Economic Research (NBER) defines an economic recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
In the European Union, recessions are defined as two successive quarters of GDP contraction. This definition is gaining traction across the world.
Forecasting a recession
Although there are no definite ways of predicting when recessions occur, there are few indicators that economists measure to detect signs that the risk of one is growing:
- An inverted yield curve
- A three-month drop in the unemployment rate
- Index of Leading (Economic) Indicators
- Assets substantially dropping in prices (including property and financial assets)
In addition to the indicators above, another signal that a recession is about to occur is a severe stock market decline. Jeremy J. Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania in Philadelphia. the author of ‘Stocks for the Long Run’, stated that since 1948 there have been ten recessions that were preceded by a stock market decline.
Annualized GDP expansions (blue) and contractions (red) from 1923 to 2009. From 1923 to 1946 data are annual, and quarterly from 1947 to the second quarter of 2009. (Image: Wikimedia)
A double dip recession is one that experiences recovery and then dips straight back into another recession. It occurs when an initial recovery fails and does not manage to gain back total economic output, thus causing the economy to slide back into decline.
“A marked contraction in economic activity. There is little agreement on a definition, but a recession is often associated with at least two consecutive quarters of declining GDP or the verification that one exists by an august body such as the National Bureau of Economic Research in the US. A global recession is often thought to be a situation when global GDP growth falls below 2 per cent.”
The Great Depression and the Great Recession
The Great Recession followed the global financial crisis of 2007/8 and the subprime mortgage crisis of 2007-2009.
The Great Depression started in 1929 and lasted till the late 1930s. From 1929 to 1932, global GDP shrank by 15%.
Depressions are much more severe and longer-lasting than a recessions.
When a country is in a recession and the central bank tries to kick-start the economy by injection money into the private banking system, sometimes the measure does not work – this situation is known as a liquidity trap. Even though loans are offered at very low interest rates, people still want to hoard cash and do not want to borrow or spend more.