What is a recession in the economy?

What is a recession?

In normal times, a country’s economy grows.

Its citizens, on average, get slightly richer as the value of the goods and services it produces – its Gross Domestic Product (GDP) – increases.

But sometimes the value of goods and services produced falls.

A recession is usually defined as when this happens for two three-month periods – or quarters – in a row.

Why does it matter if there is a recession?

For most people, economic growth is a good thing.

It usually means there are more jobs to go round. Companies are generally more profitable and can afford to pay employees and shareholders more.

Gross domestic product is a measure of the value of all the goods and services produced in an economy

A growing economy also means the government gets more money in taxes. So it has room to cut taxes, or spend more on benefits, public services and the wages of government workers.

When the economy shrinks, all these things go into reverse.

Are we in a recession yet?

Most of the developed world saw negative growth – or falling GDP – for January to March 2020, as the economic impact of coronavirus began to hit.

The official figures for April to June haven’t been published yet, but they are likely to show even bigger falls.

This would mean the second quarter of negative growth, confirming that much of the world is in recession.

The International Monetary Fund (IMF) predicts huge falls in GDP for 2020 as a whole – an extraordinary fall of 5.9% for the US and 6.5% for the UK.

In fact the IMF estimates the entire world economy will shrink by 3% this year, making it the worst recession since the Great Depression of the 1930s.

Unemployed men queuing for work during the Great Depression of the 1930s

How could a recession affect me?

Some people may lose their jobs, or find it harder to secure new opportunities and promotions.

Graduates and school leavers looking for their first job could find fewer openings available.

Those staying in work may miss out on pay rises – or have to work longer hours or accept pay cuts.

The UK government’s spending watchdog, the Office for Budget Responsibility (OBR), suggested the unemployment rate could more than double, to 10% this summer.

It also estimates that the government might have to borrow more than £300bn to cover the cost of the crisis.

However, the pain of a recession is typically not felt equally across society, and inequality can increase.

For instance, many people in the UK who owned houses with mortgages and kept their jobs during the last recession did OK. The Bank of England cut interest rates to support the economy, which reduced mortgage interest payments for many considerably, leaving them with more money to spend.

Others, such as benefit recipients or public sector workers, did less well.

What Causes Recessions?

There is more than one way for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. These phenomena are some of the main drivers of a recession:

  • A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC cut off the supply of oil to the U.S. without warning, causing a recession, not to mention endless lines at gas stations. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
  • Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in the mid-aughts that led to the Great Recession is a prime example of excessive debt causing a recession.
  • Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance,” in describing the outsized gains in the stock market in the late 1990s. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession.
  • Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession.
  • Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation. Japan’s struggles with deflation throughout most of the 1990s caused a severe recession.
  • Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements.


What’s the Difference Between a Recession and a Depression?

Recessions and depressions have similar causes, but the overall impact of depression is much, much worse. There are greater job losses, higher unemployment, and steeper declines in GDP. Most of all, depression lasts longer—years, not months—and it takes more time for the economy to recover.

Economists do not have a set definition or fixed measurements to show what counts as a depression. Suffice to say, all the impacts of depression are deeper and last longer. In the past century, the U.S. has faced just one depression: The Great Depression.

How long was the last recession?

In the UK the last recession, caused by the global financial crisis, lasted five quarters – from the second quarter of 2008 onwards. At its worst, GDP fell 2.1% in a single quarter.

Unemployment rose sharply, but it began to fall back again two years later.

And there was a massive deficit – the gap between what the government raises in taxes and what it spends on public services.

This resulted in a near-doubling of the national debt, and a decade-long program of austerity.

There were steep cuts in many areas of government spending, except health, education and international aid.

When will the recession end?

The IMF predicts the recession will be over next year and the world economy will start bouncing back.

But we are in uncharted territory, and no-one knows how strong that recovery will be.

If all the businesses which shut during the pandemic and lockdown could open quickly, the consequences of the recession would be less severe.

However, there are fears over whether the virus will start spreading again, and people may be wary of traveling or going out even if they’re told it’s safe.

Cruises, air travel, and business conferences, in particular, could take years to bounce back.

So the consequences of this recession will be felt for years to come.

economy what is a recession
Industries such as air travel could take a long time to recover from the pandemic

What can be done?

A reliable way of controlling Covid-19, such as a vaccine, would help create a strong recovery.

But until that is found, there are a few remedies available.

In the last recession, central banks cut interest rates to support the economy. That meant people and businesses could borrow more easily and had more to spend.

But interest rates are already close to zero in many places, and it may not be possible to cut them much further.

Governments around the world are already borrowing huge sums to support their economies through tax cuts and higher public spending – such as furlough schemes, support for businesses, and even direct cash payments to citizens.

But that borrowing comes at a cost, which will be felt for decades to come.

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