The Truth About Recessions: What Causes Them and How They Shape Economies

Estimated reading time: 6 minutes

A recession is a period of economic decline characterized by a decrease in gross domestic product i.e. GDP, which measures the total value of goods and services produced by an economy. It can also include a decrease in income, employment, and trade, usually lasting for at least two consecutive quarters. In this article we will understand more about the truth of recessions.

A healthy economy has lots of money flowing through it. Company owners are putting money into their businesses and hiring more people. Consumers are spending money on their products and services. But if companies and consumers stop spending that money, less money flows through the economy, and growth begins to slow. 

A recession is not the same as stagnation; rather, it is a slow or no growth period. It is also not depression, which is a more severe and long-lasting decrease. From 1960 to 2007, there were 122 recessions in 21 advanced economies. This may seem like a lot, but these economies were only in recession for about 10% of the time. Each recession is unique, but it frequently has a few traits.

Recessions typically last about a year, and a country’s GDP declines by roughly 2%; however, in very severe cases, the decline might reach 5%. Investment imports and industrial production typically fall, and the financial market is frequently in upheaval. All of this can have a significant detrimental influence on a country’s population. Many individuals lose their employment, and if they can’t manage to pay their mortgage, they lose their homes, causing house prices to fall. They also have less money to spend at stores and restaurants. This implies that enterprises make less money, and many go bankrupt.

What are a few factors that can block the flow of Money – Truth of Recessions

1. High Interest Rates

When interest rates are high, consumers get more money by putting their savings in a bank account, but they also have to sell more to get a loan. This can encourage people and firms to save more and borrow less, causing their spending to fall. Consumer confidence is a means to assess people’s psychological attitudes toward money. Economists regularly monitor this. Low consumer confidence indicates that individuals are concerned about the economy, which may lead them to save their money rather than invest or spend it. A stock market catastrophe, for example, is one of the most certain ways to erode consumer confidence nationwide.

2. Inflation

Inflation may be the most significant factor. It causes prices for products and services to rise. If your paycheck does not keep up, you will have to cut back and buy fewer items. When this happens, people and corporations tend to spend less and save more. An economic downturn that begins in one country might spread beyond its borders, resulting in a domino effect.

Let’s use the 1997 East and Southeast Asian financial crisis as an example. It started in Thailand when the value of the Thai Baht plummeted. Investors had lost faith in the country, which infected the rest of the region. The quantity of currency that travellers can carry out of the nation is strictly limited. 

Other Asian currencies, such as the Malaysian Ringgit and the Indonesian Rupiah, began to lose value. Investors around the world quickly became hesitant to lend money to any developing country.

However, the US National Bureau of Economic Research, which monitors the start and end of each US recession, believes one can begin even sooner. Aside from GDP, the agencies measure and gather monthly data on real income, employment, manufacturing, and retail. If these economic indicators decrease, GDP is expected to follow suit.

Causes of Recession Explaining the truth about recessions

There are a lot of reasons and causes for recession. A few of the important ones that are mostly impacting are mentioned below:

1. Economic Shock

Economic shock refers to any natural event, usually known as an act of God, such as a flood, earthquake, or disease. When the economy experiences shock, the demand for products and services ceases entirely. People stop buying completely; if they don’t buy, how can GDP grow? GDP is the monetary equivalent of the value of financial goods and services in an economy. When the economy does not produce goods and services, GDP shrinks. If GDP contracts for six months, a recession is unavoidable.

2. Loss of Consumer Confidence

If the consumer loses confidence in his financial position and does not want to spend money, he would prefer to save his money rather than spend it in the market. As a result, if he does not spend anything, he will not want to go to the market, and there will be no demand for goods and services. If there is no demand for goods and services, the factories that are producing them will decline or contract.

3. High rate of Interest

As interest rates become expensive, our spending reduces. For example, we thought that when the pandemic ended, we would take a loan from the bank. We will buy a car by taking a loan. Then we have come to know that after the pandemic, interest rates on loans have increased. As a result, fewer people take a loan, which means there is less spending in the market, which means there is no demand for goods and services. If there is no demand for goods and services, it means a recession is ahead.

4. Market Crash

If one day it happens that the country’s stock market falls, people start getting scared, then they stop spending money in the market. If they lose confidence in the market, then they will not spend money in the market, which means there is no demand for goods and services in the market; if there is no demand for goods and services, it means that GDP is shrinking. If GDP is shrinking for 6 months, then a recession has occurred.

In the next article, we will discuss how to prepare for an upcoming recession. I hope this article explains the truth about recessions and gives you some benefit.

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