What is Global Recession?
A global recession is a severe decline in economic activity that affects multiple countries across the world, generally accompanied by worsening of major economic indicators including Industrial production, trade, capital flows, oil consumption, unemployment rate, per-capita investment, and per-capita consumption.
Due to the tight connection between major economies of the world, economic problems spread quickly across the world. If those economic problems are big enough to bring down the gross domestic product (GDP) of major countries, that results in a global recession.
As per the International Monetary Fund, a global recession is a decline in annual per-capita real world GDP in terms of purchasing power parityPurchasing Power ParityPurchasing power parity formula depicts the variation in the exchange rate between the currencies of two different nations. It is evaluated as the fraction of a particular goods' cost in one country to that in the second country.. The decline should be perked up by the weakening of one or multiple major economic indicatorsEconomic IndicatorsSome economic indicators are GDP, Exchange Rate Stability, Risk Premiums, Crude Oil Prices etc. including Industrial production, trade, capital flows, oil consumption, unemployment rate, per-capita investment, and per-capita consumption. In the U.S., the economy is considered to be in a recession when the economic activity, measured by GPD, falls for two consecutive quarters.
Example of Global Recession
- As per the world bank definition of recession the world has experienced four recessions post World War II. These recessions happened in 1975, 1982, 1991, and 2009. Of these recessions, the 2009 recession was worst in terms of its impact on the world and the decline in the GDP. During the 2009 recession, also called the Great Recession, the economy collapsed led by the fall of the real estate market in the United States, putting all the major economies around the world in some degree of crisis. Widespread defaults in the housing market led to the subprime mortgageThe Subprime MortgageA subprime mortgage is a loan against property offered to borrowers with a weak or no credit history. Since the risk of recovering is high, the interest rate charged on such mortgages is higher so that the lender can recover a maximum amount at the beginning of the loan. crisis.
- In the U.S. housing boom prior to this period, banks lent aggressively to subprime borrowers, disregarding the repayment capacity of those borrowers. Big investment banks bought these loans from banks, packed them into investment securitiesInvestment SecuritiesInvestment securities are purchased by investors, with or without the assistance of a middleman or agent, solely for the purpose of investment and long-term holding. These are recorded in the financial statements as non-current investments and comprise fixed income and variable income bearing securities., and sold them to investors across the world. When the borrowers defaulted, the securities based on these loans became worthless and the investors around the globe suffered heavy losses.
- The recession lasted from December 2007 to June 2009 and it severely impacted the developed countries, especially the U.S. The country’s GDP fell by 4.3%, house prices declined by 17.3% and the unemployment rate peaked at 10% in October 2009. The federal reserve had to run multiple bailout programs to keep systemically important entities from drowning and getting closed.
- It also brought down interest rates to near zero and kept them there for a long period to bring back the economy to the pre-recession levels. The impact of the Great Recession varied across the globe. Developed economies saw a decline in their GDPs while emerging economies like China and India continued to see robust growth.
Causes of Global Recession
Global recessions can be caused by multiple factors including, but not limited to, wars, asset price collapse, energy and commodity price collapse, drying demand, reduced consumption, reduced wages and a general decline in consumer and investor confidence. The situation gets aggravated by extreme risk aversenessRisk AversenessThe term "risk-averse" refers to a person's unwillingness to take risks. Investors who prefer a low-return investment with known risks to a higher-return investment with unknown risks, for example, are risk-averse. that catches up when the recession unfolds.
Effects of Global Recession
A global recession impacts countries across the world and hurts governments and private enterprises alike and its major effects of are described below.
- Global recession leads to high unemployment and a decline in wages. Workers are laid out as corporations try to save themselves from deepening losses.
- High unemployment and lower wages force consumers to hold back on spends, further aggravating the impact of the slowdown.
- Investors hold back on investments and redeem existing investments leading to the collapse of prices of risky assets.
- Financial institutions face widespread defaults that eat into their net worthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus. and sometimes also lead to bankruptcies.
- Safe-haven assets like Gold see an increase in price as investors chase these assets to safeguard their capital.
- In the aftermath, the regulators plug the loopholes and create new regulations to prevent any future crisis.
Recessions are not generally good as they result in widespread destruction. However, there are also some advantages that should be highlighted –
- Global recessions lead to the neutralization of excesses. Economies build excesses in general courses and get heated up reaching a level that is not sustainable. In this case, Recessions do the requisite course correction.
- It helps the leaders understand the vulnerability of their economies to various factors including commodity prices, lax regulations, etc.
- In its aftermath, recession brings about greater efficiency in the functioning of businesses and the economy.
- Asset prices revert back to normal levels providing investment opportunities to buyers and investors.
Global recession does a lot of harm in the short run and it takes a significant amount of heavy lifting for the economies and businesses to get back in shape. The following are some of the most prominent disadvantages –
- Economic output falls leading to lower wages, high unemployment and a decline in consumption expenditure.
- They leave a significant strain on the 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. of governments and monetary authorities as they dole out more and more money to save the economy from collapsing.
- For some countries, the exchange rate sees a significant depreciation, putting their economies at the risk of complete collapse.
- Asset prices collapse and investors incur significant investing losses.
- Inequality and poverty increase leading to social problems in some vulnerable economies.
- Governments become more protectionist, which impacts free trade and investment, leading to a further slowdown in business.
As per the IMF, a global recession happens every 8 to 10 years. Depending on the excesses or other factors that lead to recession, the severity of these recessions varies. Governments and monetary authorities, with some success, try to balance and regulate critical aspects of the business and economy to prevent recessions from happening.
The impact of the global recession varies from economy to economy. Economies that are heavily dependent on foreign trade for their fortunes witness a higher impact while the ones that are self-sufficient witness a lesser impact. Irrespective of the nature of the economic activity, policymakers have to jump into the damage control mode when this recession happens to safeguard their economies from the outbreak.
This has been a guide to what is the global recession and its meaning. Here we discuss an example of a global recession along with causes and effects. You can learn more about financing from the following articles –