Why Do Recessions Happen?

Economy, Personal Finance



We hear the word recession all the time?  But what is it and why do recessions happen?  The impact of an economic recession is utterly wide-ranging. Depending on its nature and extent, a recession’s effects can be huge or minimal, direct or indirect. In any case, a recession is something that everyone should care to know about.

But in order to care about it, you must know what a recession is and why it happens.  According to the National Bureau of Economic Research (NBER) in the US, a recession refers to a considerable decline in economic activities happening at a wide scale, which lingers for several months and is visible in macroeconomic data such as national output, employment, and industrial production, among others.  Although the word recession gets thrown around a lot for periods of economic uncertainty or inactivity, it is often used by economists and business leaders to mean (at least) two consecutive quarters of GDP decline.  But enough with the technicalities, here are some of the reasons why recessions happen in the economy:

Inflation

Inflation refers to the general rise in the price of goods and services; it is caused when there are, for instance, oil price hikes, higher production costs, and huge government debt. A higher rate of inflation lowers the value of each dollar earned by an individual.  With prices being high, people would tend to reduce overall spending. The moment consumer demand contracts, the economy becomes sluggish until it reaches a level where the effects become grand in scale. With businesses losing money due to low sales, they start to lay off workers, and people would become even more cautious in spending. Once this trickles down to the entire economy, recession begins.  This is probably the biggest reason for recessions.

READ  List of Economic Indicators to Guide Your Investment Decisions

Housing Bubble


The recession of 2008 started with the unreasonable exuberance of people in the housing market. Many people bought houses they could not afford, with the thought that its price will continue to go up. It was then very easy to get a loan from the bank. The housing bubble burst as prices began to fall. Many have foreclosed as a result. This caused a panic of a large scale among many banks. The fall of large banks followed and this had a ripple effect to the real sectors – the producers of goods and services.

Irrational Excitement in Technology Companies

The recession of 2001 was caused by too much excitement in technology companies. The Y2K scare in 1999 had many companies buying new computer systems to ensure their equipment is Y2K compliant. This led to a sharp increase in the stock price of many high-tech companies, even at times when they are not performing well in terms of profits. However, once the Y2K scare disappeared, the demand for computers went down drastically because companies did not replenish their equipment until after two years, which is the shelf life of a computer. This resulted to a sell-off in the stock market causing the value of tech companies to fall. Many of these went bankrupt, and it affected the entire economy.

Too High or Too Low of Interest Rates

High interest rates limit liquidity or the amount of money available for investment. Despite of the stock market slump in March of 2000, the Federal Reserve went on raising interest rates when it should be lowering them to encourage business loans and mortgages. Also, the Fed was quite slow to raise interest rates when there was a boom in the economy in 2004. These low rates helped developed the housing bubble that happened in 2008.

READ  The Stock Market and the Business Cycle: Their Correlative Relationship

Recession in a Major Trading Partner


For a country that largely depends on the demand of a major trading partner for its exports, an economic crisis in the partner’s country can also cause a recession in the exporting country.

No one knows what the next recession will be like or what will prompt it.  But the only thing certain is that the economy will continue to evolve as people carry on, bearing the lessons learned from past experiences.

How Often Do Recessions Happen

So now that we understand why recessions happen, we can go onto how often it happens.  Although recessions are by no means “a good thing” for the overall population, it is a part of the normal business cycle.  Recessions typically happen every 8-9 years, give or take a couple of years, and economic anomalies.  In the 20th century alone, there were 12 recessions.  And in the 21st century, we have already been through two recessions; the early 2000s recession which last eight months (from March 2001 to November 2001) and there was also the Great Recession, which last one year and six months (December 2007 to June 2009).

How Can You Tell When There’s  a Recession?

Recessions are based off of gross domestic output (GDP) numbers.  And since GDP numbers report what has went on in the past, we are not able to officially declare recessions until it has already happened.  However, just because there is no official declaration of a recession doesn’t mean you can’t tell that there is one.  Here are some strong indicators that we are in a recession:

  • Massive layouts across multiple business sectors
  • Reduced manufacturing
  • Rise in unemployment rate
  • Reduced consumer spending
READ  Recessions in the US Since the 20th Century and What Caused Them

And like it was previously stated, recessions are defined as reduced economic output for at least two consecutive quarters (6 months).  So when looking for those bullet-point trends, remember to look at the trends for several months at once and not just one or two months.

Are We Currently in a Recession?

Although many have been led to believe that we are still in a recession, we are not.  Believe it or not, our GDP is growing, albeit very slowly.  Our unemployment rate is also trending downwards, albeit also very slowly.  Consumer spending is trending upwards, also very slowly.  So the final answer is, no we are not in recession right now.  The last recession ended in June of 2009.


Advertisement

Comments on this entry are closed.