Economic Recession Definition
Economic recession is defined as the phase in which economic activities of a country become stagnant, leading to a disturbance in the business cycle and affecting the overall demand-supply balance. Though the recession is a negative economic phenomenon, it is still appreciated when it occurs, as it instills a sense of vigilance in the individuals and administration of the economy, making them keep a check on the possibilities of recession.
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An economic recession might last from a few months to a few years, indicating a disturbance in the economic scenario. It is, however, different from depression, which lasts for years, marking an extreme downfall in the economy.
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- Economic recession is when economic activity is stagnant, causing business cycle contraction, demand-supply network disbalance, increased unemployment rates, etc.
- The increased level of inflation, higher interest rate, rising commodity prices, and higher fiscal deficit results in an economic crisis.
- The economic scenario is replicated in the stock market also. The index trades at a lower valuation, as most investors remain aloof from the market.
- Recessions takeaway normal economic activity levels. As a result, the country’s GDP and individual income decline.
Economic Recession Explained
An economic recession is identified when the economic activities of a nation undergo deterioration for more than two quarters in a row. In the United States, the National Bureau of Economic Research (NBER) is responsible for identifying and specifying the start and end dates of the recessions.
A recession is an inevitable part of the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline., which is likely to and should arise once in a while to help economies halt the unnecessary expenditure they make carelessly. During a recession, the countries witness huge disturbance in the economic cycle, including deterioration in the sales figure, increased unemployment rate, and diminishing economic output.
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The Gross Domestic ProductGross Domestic ProductGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period. (GDP) has long been considered one of the major indicators of economic recession. However, the NBER states that the decline in quarterly GDP does not necessarily mean recession. A GDP indicates the total revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. an economy generates through the sale of commodities, goods, and services.
When the employment rate deteriorates, the population’s income level decreases, thereby reducing the purchasing power of the economy. As a result, the stock prices undergo serious fluctuations, leading to stock market crashesStock Market CrashesA stock market crash occurs when stock prices in all sectors begin to fall rapidly. It is often the result of global factors such as war, scam, or the collapse of a certain industry. In such a crash, panic acts as a catalyst.. The performance of the manufacturing and retail/wholesale industry also serves to be an important indicator of recession.
Multiple factors are responsible for the global economic recession. The causes of such phenomenon are interrelated. For example, when the demand for a product is high in the market with limited supply, it increases the cost of the commodities. As a result, the lack of demand-supply balance leads to the signs of inflation, which get severe over time.
The central banks of the economies around the world raise the interest rates to control inflation. As taking loans is unavoidable for citizens sometimes, their debt burden becomes unbearable because of the rising interest rates. As they default on repaying the installments, the economic activities stagnate, causing the recession.
The sudden shocks, including natural calamities, severely affect the market and business cycle, damaging financial affairs and activities. One of the examples of such turmoil is the market scenario during Covid-19.
The fluctuation in the prices of the commodities and the market disturbances lead to reduced consumer confidence. As a result, people stop investing much in the products and services, which adversely affects the economic cycle of a nation, leading to recession.
Above all, the fear of recession is also a major cause. Of course, there might not be chances of a recession, and the market might be active enough. Still, if a major population psychologically prepares itself to control investments, it will lead to a shortfall of funds or revenue generation in the market. Thus, psychological factors too play a great role in causing a recession.
Some of the major effects of economic recession are as follows:
- Increased unemployment rate
- Reduced purchasing power
- Business bankruptcy, leading to bailoutsBailoutsA bailout refers to the prolonged financial support offered by the government or other financially stable organization to a business in the form of equity, cash, or loan to help it overcome certain losses and stay afloat in the market.
- People default on their mortgage loan
- Credit availability criteria turn stricter
- Short-term interest rates fall
- A decrease in consumption rates reduces inflation, which likely causes deflationDeflationDeflation is defined as an economic condition whereby the prices of goods and services go down constantly with the inflation rate turning negative. The situation generally emerges from the contraction of the money supply in the economy..
During a recession, the cost of borrowing stays lower. Due to the low purchasing power, the central banks reduce the interest rate to revive the economy. Thus, a good business can opt for a corporate loan at a lower rate. That can also be applicable for retail customers as the individual can opt for a house loan or a vehicle loan, and the interest cost would be lower. In doing so, the government has to increase its spending, thereby reducing the tax burdens on individuals and businesses.
For investors, one of the best strategies to have during a recession is to invest in companies with low debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state., good cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. , and strong balance sheetsBalance SheetsA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.. It is conversely recommended to avoid highly leveraged, cyclical, or speculative companies. Moreover, businesses must prioritize spending more on technologically sound infrastructureInfrastructureInfrastructure refers to fundamental physical and technological frameworks that a region or industry establishes for its economy to function properly.. In short, focused decision-making is a must.
During the recession, the job sector witnesses the worst effect as people start losing jobs because of the economic disturbances across the nation and the globe. Layoffs not only harm employees but are also costly affairs for companies that have to bear the cost of hiring and training individuals repeatedly.
There are, however, many other alternatives besides laying off, which could be implied for bringing the economy back on track. For example, companies can reduce the number of working hours and the performance pay to save some costs during a recession.
Let us consider the following economic recession examples to understand the concept better:
Example 1 – 2008 Economic Recession
The 2008 financial crisis saw the downfall of the Lehman Brothers, one of the dominant market players in the US banking sector. This resulted in the fall of subprime lending in the country, leading to reduced bank liquidity. The 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. , which offered credits to individuals leniently without conducting any financial checks. As a result, the frequency of defaults increased, turning the credits into 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., which caused lower liquidity.
Example 2: Upcoming Economic Recession
Recently, there have been signs that indicate an economic recession in 2022. In addition, the Russia- Ukraine war seems to cause an increase in the interest rates, slowing down the economic growth, indicating US economic recession.
The US market has been witnessing inversions in the government bondGovernment BondA government bond is an investment vehicle that allows investors to lend money to the government in return for a steady interest income. market since the commencement of the war. Though the economists are not guaranteeing a recession, the inversion observed has been a major factor leading to previous periods of recession. This, in turn, indicates the possibility of an upcoming recession.
Economic Recession vs Depression
Though economic recession sounds similar to depression, the terms differ in their intensity. While the economic downturn is indicated through a continuous decline in the economic activities for consecutively two quarters, depression is reported when the recession continues for a significantly longer period.
In short, depression is a situation where there is prolonged stagnancy in economic activities, and the economy fails to revive despite several government interventions.
A prolonged recession causes depression, lasting too long, with impacts worse than those observed during the economic slowdown. The most common example of a recession and depression is the global recession of the 2008 financial crisis and the Great Depression of the 1930s, respectively.
Frequently Asked Questions (FAQs)
Economic recession is a phenomenon whereby a country witnesses stagnant economic growth. A recession occurs when economic activities significantly slow down for at least two consecutive quarters. Such situations lead to business cycle contraction, demand-supply network disbalance, unemployment rate enhancement, etc.
Given the effect of COVID-19 on the market, various nations have shown signs of recession in 2020. Though the administrators around the globe have been trying their best to take the world out of the pandemic’s recession-driven impact, the Russia-Ukraine war has worsened the situation, indicating more severe effects.
A recession can be dealt with quite well if every individual takes the responsibility to do so. Individuals and businesses can prepare a wiser monthly budget and plan fruitful investments to ensure they manage their wealth well. Keeping extra funds for emergencies and repaying high-interest debts as soon as possible can also help an economy remain out of recession.
This article is a guide to what is Economic Recession & its definition. Here we explain its indicators, causes, impact, and overcoming measures with examples. You can learn more about economics from the following articles: –