A recession is when there has been an overall decline in the economy for a few months, typically 6. People also look at certain factors to determine when there is a recession. A reduction in factors such as real GDP, real income, manufacturing strength, employment and retail sales are used to come to a decision on if we are in a recession or not.
A recession is usually under way when there are a few months of slowing but positive growth. Often a quarter of negative growth will occur followed by some positive growth and then more negative.
A fall in consumer demand
A fall in consumer demand is usually the cause of a recession. As consumer demand falls, businesses makes less profit, pay less taxes to the government and in the long run lay off more staff and hire less people. This means there will be more people with less money to spend on goods and no working income to pay tax on. This ofcourse means less income for the government.
Recessions can also be caused by:
- Financial crisis
- Large-scale fraud
- Leads to unscrupulous lending and investing practices, which can lead to bank or investment fund failures
- Energy crisis
- Currency devaluation
- Decline in consumer confidence
- Supply-Demand imbalance
- Irrational exuberance
- When consumers borrow more than they can afford to because they think asset values will continue to climb forever, such as during the housing bubble that preceded the 2008 crash.
- High interest rates
- Economic slowdown after a war
- Credit crunch
- When banks stop lending to each other
Recessions can cause lenders to raise interest rates in a bid to generate extra revenue or due to the high cost of borrowing the funds they lend( borrowing becomes more expensive for lenders as everyone becomes wary. Central banks may raise their rates to combat the increased risk of a bank which they lend to defaulting). This in turn can affect consumers with existing variable rate mortgages as their monthly credit repayments rise and if this becomes unaffordable then they will eventually lose their homes due to not keeping up on their mortgage repayments.
Businesses may also go bankrupt as they fail to keep up on any credit(borrowing) commitments they have and this in turn affects the amount of jobs on the market.
Recessions also cause:
- High unemployment
- Jobs are difficult to get; highly competitive job market
- Declining stock market trends
- Decreased consumer spending
- Large layoffs
- Decreased wages
- Increasing interest rates
- Increased number of home repossessions
Kickstarting the economy
Governments will usually try to kick start the economy through monetary and fiscal policy.
They may reduce interest rates to reduce the cost of borrowing money. This will encourage us to spend more as our credit card APRs are now lower.
They may also reduce taxes and this will give us more income to spend, which keeps more businesses afloat and in turn creates more jobs.