Economic Recession

Economic Recession Definition

Economic Recession is the phase where economic activity is stagnant, contraction in the business cycle, over-supply of goods compared to its demand, a higher rate of the jobless situation resulted in lower household savings and lower expense and the Government is unable to cope up certain economy and cumulation of inflation, higher interest rate, the higher commodity pieces, higher balance of payment and higher fiscal deficit that results in economic crisis.

Types of Economic Recession

As per the nature of occurrence, recession can be classified into three categories namely:

  1. Boom and bust cyclesBoom And Bust CyclesBoom and Bust Cycle is the Gross Domestic Product (GDP) cycle of upward and downward movements along with its long term trend. It helps identify the level of production in the economy and the performance of the associated economic indicators such as employment, inflation, stock performance, and investor behavior.read more recession come after the economic boom and are characterized by higher inflation, higher commodity prices, higher interest rates, etc.
  2. A Balance sheet recession occurs when there is a drastic fall in business incomes followed by a fall in the firm’s asset value and higher corporate borrowings.
  3. Depression is a situation where there is prolonged stagnancy in economic activities and the economy fails to revive despite several government interventions.

Examples of Economic Recession

Below are some examples of Economic Recession.

Example #1

During 2008-09, there is drop-in bank liquidity due to a fall in subprime lending in the USA. The recession was marked by the fall of one of the leading banks in the US, the Lehman brothers. Credit growth was exponential for the banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more resulting in limitless credit to the individuals. A person having earnings of $1000 has been offered $10000 worth of credit limit. As a result of the default, the credit provided by the banks became non-performing assetsNon-performing AssetsNon-Performing Assets (NPA) refers to the classification of loans and advances on a lender's records (usually banks) that have not received interest or principal payments and are considered "past due." In the majority of cases, debt has been classified as non-performing assets (NPAs) when loan payments have been outstanding for more than 90 days.read more. Thus, the overall scenario became tepid resulting in lower liquidity.

Example #2

During 2001, the GDP growth of the US fell by 0.3%. This was an example of a short-lived recession. The fall in the gross domestic product was primarily due to lower consumer sentiment due to the attacks of 9/11. However, these types of economic situations are not permanent in nature. The recession continued for a span of a few months only.

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How to Benefit from Economic Recession?

  1. During a recession, the cost of borrowings stays lower, due to the low purchasing power, the central bank reduces the interest rate in order to revive the economy. Thus, a good business can opt for a corporate loan at a lower rate. This can be applicable for retail customers also as the individual can opt for a house loan or a vehicle loan and the interest cost would be lower.
  2. The economic scenario is replicated in the stock market also. The index trades at a lower valuation, as most of the investors remain aloof from the market. But, on the contrary, there are a handful of smart investors who banks their money into stock with fundamentals trading at the cheapest valuation. Thus, for investing point of view, an economic recession is positive for investors.
  3. Prices of properties remain lower as there is a lower demand prevailing in the economy. Smart home buyer opts for property investment during this phase.

Dis-advantages of Economic Recession

  1. The corporate earnings tend to decrease followed by a lower level of firm output, a higher rate of inventory, creation of jobless situations resulting in a fall in household incomes.
  2. Gross domestic product decrease because of a fall in the overall earnings potential of individuals and corporates.
  3. Due to the fall in consumer sentiments, earnings, lower firm’s output levels, the overall liquidity in the economy goes down.
  4. The income of individual drops due to the jobless situation and lower wage rate. The demand for luxury items diminishes. People only spend on necessary articles.
  5. Most of the measures taken by the Government fail to revive the economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others.read more.
  6. During a recession, the shape of the economy remains blurry- fiscal deficit tends to widen followed by demand-supply mismatch and loss of balance of paymentBalance Of PaymentThe formula for Balance of Payment is a summation of the current account, the capital account, and the financial account balances. The term balance of payments refers to the recording of all payments and obligations pertaining to imports from foreign countries vis-à-vis all payments and obligations pertaining to exports to foreign countries. It is the accounting of all the financial inflows and outflows of a nation.read more.
  7. The prices of a commodity tend to go higher, prices of precious metals tend to increase as investors go for a safer place for investing. For ages, gold has been a safe haven for investors and during hard times, investors rely upon their safer bets.

Limitations of Economic Recession

  1. Recessions take away normal economic activity levels. The country’s GDP declines, so as individual income.
  2. The real income of an individual or a firm tends to slow down. Because of the lower-wage rate followed by a higher jobless rate, the individual income tends to get decrease. The overall decrease in household income reduces per head spending and affects firms’ output.
  3. Widening of fiscal deficitFiscal DeficitFiscal deficit refers to the situation where the total budget expenditure exceeds the total budget receipts, excluding the government borrowings in a given fiscal year. It determines the amount the government needs to borrow for meeting its excess expenditure.read more is a common phenomenon of recession.
  4. The interest rate prevailing in the economy tends to go down as the central bank lowers the interest rate so as to maintain the banking activity at optimum levels followed by higher liquidity.
  5. A decrease in sales of high margin products is another limitation of economic recession. Buyers tend to cut their spending during the recession and their overall spending is characteristic of necessary products only.

Important Points

  1. The economic recession is highlighted by lower gross domestic product, lower inflation rate, and lower liquidity.
  2. The supply across all the segments becomes higher and the overall demand for goods remains lower.
  3. Another interesting phenomenon can be seen during a recession, fluctuations across commodity prices. The price of aluminum, steel, etc tends to decrease whereas prices of precious metals like silver, gold, etc tend to rise. Investors opt for safer assets and lower down their consumption for daily goods.

Conclusion

The economic boom was created due to higher business profits, higher spending across value-added products, and higher inflation. The supply of money becomes higher and a sudden jerk leads to lower liquidity and lower demand for high margin products creating a lower wage rate and lower salary of employees.

This has been a guide to the Economic Recession and its definition. Here we discuss types and examples of economic recession along with advantages and disadvantages. You can learn more about Financing from the following articles –

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