The National Bureau of Economic Research (NBER) defines a recession as “a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” A recession is also believed to be signalled when businesses cease to expand, the GDP diminishes for two consecutive quarters, and the unemployment rate rises. The nature and causes of recessions are simultaneously evident and uncertain. Recessions are, in essence, a cluster of business failures being realized simultaneously. Firms are forced to reallocate resources, scale back production, limit losses, and, usually, lay off employees. Those are the clear and visible causes of recessions. There are several different ways to explain what causes a general cluster of business failures, why they are suddenly realized simultaneously, and how they can be avoided.
What Causes a Recession?
Some recessions can be traced to a clearly-defined cause. For instance, the recession of 1973-1975 began as a result of the 1973 oil crisis. However, most recessions are caused by a complex combination of factors, including high interest rates, low consumer confidence, and stagnant wages or reduced real income in the labour market. Other examples of recession causes include bank runs and asset bubbles.
Psychological Factors of a Recession
Psychological factors are frequently cited by economists for their contribution to recessions also. The excessive exuberance of investors during the boom years brings the economy to its peak. The reciprocal doom-and-gloom pessimism that sets in after a market crash at a minimum amplifies the effects of real economic and financial factors as the market swings. Moreover, because all economic actions and decisions are always to some degree forward-looking, the subjective expectations of investors, businesses, and consumers are often involved in the inception and spread of an economic downturn.
Economic Factors of a Recession
Real changes in economic fundamentals, beyond financial accounts and investor psychology, also make critical contributions to a recession. Some economists explain recessions solely due to fundamental economic shocks, such as disruptions in supply chains, and the damage they can cause to a wide range of businesses. Shocks that impact vital industries such as energy or transportation can have such widespread effects that they cause many companies across the economy to retrench and cancel investment and hiring plans simultaneously, with ripple effects on workers, consumers, and the stock market. There are economic factors that can also be tied back into financial markets. Market interest rates represent the cost of financial liquidity for businesses and the time preferences of consumers, savers, and investors for present versus future consumption. In addition, a central bank’s artificial suppression of interest rates during the boom years before a recession distorts financial markets and business and consumption decisions.
What Are the Indicators of a Recession?
Economists determine whether an economy is in recession by looking at a variety of statistics and trends. Factors that indicate a recession include:
- Rising in unemployment
- Rises in bankruptcies, defaults, or foreclosures
- Falling interest rates
- Lower consumer spending and consumer confidence
- Falling asset prices, including the cost of homes and dips in the stock market
All of these factors can lead to an overall reduction in the Gross Domestic Product (GDP). The European Union and the United Kingdom define a recession as two or more consecutive quarters of negative real GDP growth.
Impact of Covid-19 Pandemic on the Economy
In February 2020, the National Bureau of Economic Research (NBER) announced that according to their data, the U.S. was in a recession due to the economic shock of the widespread disruption of global and domestic supply chains and direct damage to businesses across all industries. These events were caused by the COVID-19 epidemic and the public health response. Some of the underlying causes of the two-month recession (and economic hardship) in 2020 were the overextension of supply chains, razor-thin inventories, and fragile business models. The pandemic-related recession, according to NBER, ended in April 2020, but the financial hardship caused by the pandemic is still impacting Americans.
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