What Is Economic Recession: Causes And Way Out

An economic recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. That temporary decline is not necessarily less than a year, however; sometimes it is several years, enough to be pretty uncomfortable.

In a recession, money is tight, banks pull back, hard to get loans. Because money is tight, companies cannot get money, so if they need it urgently, they may go under. If they need it for expansion, they won’t expand until after the recession. If people have credit cards or mortgages that go up and down with the interest rate, the interest rate will go up, so you pay more.

Difference Between Inflation And Economic Recession

Inflation is a gradual continuous increase in the price of goods and services compared to some benchmarks. Inflation can mean either an increase in the money supply or an increase in price. But if the money supply has been increased, prices will increase. So, inflation is a concept about the value of money.

A recession is a concept about the output of an economy.

Inflation occurs when money in your pocket is worth less tomorrow than it is today in terms of what it can buy. If it is worth MORE tomorrow than today that is deflation.

There are multiple causes of both. The simplest is excess demand. If you are alone in a mining town with 100 other miners, and a wagon arrives with 4 shovels–there will be money inflation for shovels!

On the other hand, if you are all easily finding gold hand over first then shovels will demand more gold!

A recession (or in its bigger form–Depression) is when the value of all goods and services sold in a time series period is less than in the previous period. For example, take a quarter year. If Q1 has a total output (people say GDP–gross domestic product) of 100, and Q2 has a total GDP of 95, you are in a recession.

The expectation is that the total value of goods and services in a given time period continues to go UP. The economy is said to be EXPANDING. If it goes down… the economy is said to be CONTRACTING.

When a person builds a factory, they never build it to make its total amount of capacity on the first day. They build it to make enough capacity to achieve a product. If they can produce even more–they can grow or EXPAND. If economies are contracting, more and more businesses slip to a point where they can’t pay their workers or their bank loans, etc. and they CONTRACT. When this happens… demand goes down… and it swirls downward like a toilet.

In economics, one can connect the value of money to the growth of an economy. This is the work of central banks–like the Fed. It is mysterious and complex stuff best left to wizards and people who brew potions and draw pentagrams in the night.

Causes Of Economic Recession

Recessions are caused by a variety of factors that are different from recession to recession. The most generic way to describe the cause of a recession is to say that recessions are caused by shocks and imbalances in the economy.

Unemployment Rate

There have been a lot of recessions since World War II and unemployment has spiked in all of them. Sometimes unemployment comes down quickly and other times it comes down slowly or even lingers (also known as a jobless recovery). Let’s look at the main cause for four US recessions below.

Supply Shock

Recessions can be caused by a sudden shock in supply. This shock can come from a major spike in the price of a commodity like oil. This is exactly what happened in the mid-1970s when OPEC restricted oil supplies driving up the price of oil.

Bubble Bursting

The bursting of a bubble can cause a recession. People feel poorer and spend less as a result of weakening the economy. The bursting of the dot-com bubble in the early 2000s is an example of the deflation of a bubble leading to a recession.

Financial Crisis and Deleveraging

A financial crisis and too much debt in the private sector can cause a severe recession. Financial institutions getting into trouble can force them to lend less, causing a credit crunch. Too much borrowing by households beforehand will force them to cut spending when they can’t access credit anymore to pay down their debt, causing a major economic slowdown. The 2008 financial crisis was an example of this and so was the Great Depression.

Contractionary Monetary Policy

A recession can be caused by contractionary monetary policy. This usually happens when a central bank is trying to fight inflation or protect the value of a currency. In the early 1980s inflation had gotten out of control in the U.S., so the Federal Reserve hiked interest rates to combat it. Higher interest rates caused credit to contract and slow inflation, but the credit contraction also had the unfortunate side effect of causing a recession.

Way out Of Economic Recession

  • High rates of saving and investment: This can be achieved through household and business savings, tax incentives, and others.
  • Investment in technology and education will also stimulate growth.
  • The government should collaborate with foreign technical experts in other to learn from experiences and insights which will be used to develop policy.
  • Identify ways to cut back on spending.
  • When banks find it difficult to raise capital in the market, the authorities should consider the possibility of injecting public funds. Such recapitalization with the state budget; the authorities should also be committed to managing the recipient bank to take due responsibilities and its existing shareholders to incur possible losses.

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