What Is A Recession?
A major slowdown in economic activity that is widespread and continues for an extended period of time is referred to as a recession. According to a common heuristic, a recession is defined as a period in which the country's gross domestic product (GDP) has decreased for two consecutive quarters. During a recession, the economy often experiences a drop in production and a decrease in consumer demand and employment.
As defined by the National Bureau of Economic Research, a downturn is a period of economic decline that begins at the apex of the preceding boom and ends at the trough of the subsequent downturn. [1]
About Recessions
Since the beginning of the Industrial Revolution, most nations' economies have expanded, with occasional periods of decline serving as the norm rather than the exception. A recession is a short-lived phase of the business cycle that serves to fix any problems that may have arisen during the boom period.
In the current period, economic downturns have become less frequent. They have a shorter duration, although they are a regular aspect of the landscape. According to the International Monetary Fund, 122 recessions affected 21 advanced countries between 1960 and 2007, and these recessions persisted nearly 10% of the time (IMF). [2]
The decreases in economic production and employment that downturns create may spiral and become self-perpetuating. This is because recessions constitute an abrupt reversal of the normally prevailing growth trend. For instance, a decrease in consumer demand might lead to layoffs, affecting the revenue and spending of newly jobless people and leading to even lower demand.
Consumption reliant on growing asset prices and greater net worth tends to decrease during a recession. Similarly, bear markets in equities, which commonly accompany economic downturns, may reverse the wealth effect. If financial institutions reduce the amount of capital they provide to small firms, it will be difficult for these companies to continue expanding, and some may even fail.
During a period of economic contraction, one of the effective techniques for investors is to put their money into businesses with manageable levels of debt, healthy levels of cash flow, and robust balance sheets. On the other hand, it is preferable to avoid purchasing shares in highly leveraged, cyclical, or speculative firms until the recession is over. At this point, the survivors among them frequently start outperforming the rest of the group.
The precise moment at which such economic inflection points occur is only possible to ascertain if one looks forward. It is not helpful that investors, economists, and workers are all likely to characterize a recession differently regarding its significant impacts. This makes it more difficult to plan for the future. Workers may only believe a recession will be finished once the economic recovery has been underway for months or even years. This is because unemployment rates often stay high even after the economic trough.
Even if consumer spending and employment levels continue to improve, an investor may conclude that a recession has already begun if capital losses continue to mount and corporate earnings continue to decline. This is because declines in the stock market frequently precede economic downturns.
What Are the Causes of A Recession?
Many economic theories seek to explain why and how the economy may deviate from its long-term growth pattern and enter a recession. These ideas may be divided into three main categories: those founded on economic, monetary, or psychological considerations, with some of them spanning the boundaries between these categories.
Some economists emphasize economic transformations, such as radical business reforms, as the essential factor. For instance, an abrupt and sustained increase in oil prices due to a geopolitical crisis might cause costs across the economy to rise, while the rapid introduction of new technology might quickly render entire industries obsolete.
One example of a shock that might cause a recession is the COVID-19 pandemic in 2020 and the public health limitations enacted to stop its spread. There is also the possibility that an economic shock does nothing more than hasten the beginning of a recession that was always going to occur due to other economic variables and imbalances.
One possible explanation for recessions is that aspects of the economy cause them. These often center their attention on the expansion of credit and the buildup of financial hazards during the prosperous years that came before the economic downturn, the reduction of credit and money supply at the beginning of a recession, or both of these factors. One prominent example of this kind of theory is monetarism, which holds that an inadequate increase in the quantity of money in circulation causes economic downturns.
In order to explain why economic downturns can occur at all and even linger for extended periods, psychological explanations of recessions typically center their attention on the extreme optimism accompanying economic expansions and the deep pessimism that can characterize their aftermath. The Keynesian economic theory emphasizes the many economic and psychological aspects that might exacerbate and drag out recessions. The term "Minsky Moment," coined by the American economist Hyman Minsky, merges the financial and psychological paradigms to highlight the ways in which bull market exuberance may distort the incentives of economic players and promote unsustainable speculation.
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