Economic Recession

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.

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.

• 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.

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 cycle, 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.

The Gross Domestic Product (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 revenue 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 crashes. 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 bailouts
• 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 deflation.

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 debt, good cash flow, and strong balance sheets. It is conversely recommended to avoid highly leveraged, cyclical, or speculative companies. Moreover, businesses must prioritize spending more on technologically sound infrastructure. 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 institutions, 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 assets, 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 bond 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.

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.

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: -

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